Assets Under Management Fall for Hedge Funds

According to eVestment LLC, investors in hedge funds and hedge funds of funds withdrew $30.8 billion in the first half of 2016, bringing down the total assets under management to $3 trillion for the entire industry.  Poor performance seems to be the driver for the redemptions.  The HFRI Fund Weighted Composite index fell 2.4% during the same timeframe.  Momentum investors, who search for "the latest hot hedge fund performer", have nothing to invest in.  Kenneth J. Heinz, president, Hedge Fund Research Inc., said that investors are also re-allocating assets due to a change in tactical or strategic investing strategy or even re-balancing assets.

The usual suspects comprised the list of the largest hedge fund managers:  Bridgewater, AQR Capital Management and Man Group.  Several managers were off the list because of divestitures (J.P. Morgan Asset Management), non-responsiveness to the survey (Davidson Kempner Capital Management, Appaloosa, Pershing Square Capital Management, Paulson & Co. and Third Point) and spin-offs (Black River Asset Management).

The same was evident in the list of hedge funds of funds manager:  Blackstone Alternative Asset Management, UBS Hedge Fund Solutions and Goldman Sachs Asset Management.  There were a couple of deals (Entrust Capital Management and Permal Group) and (Aberdeen Asset Management and Arden Asset Management) that changed the rankings of the biggest managers.  The first merger was a response to competition from investment consultants.  The strategy is to "offer specialized, unique, niche-y strategies" according to Gregg Hymowitz, chairman and CEO of EnTrustPermal.

For the first half of 2016, 58% of hedge fund managers and 63% of hedge fund of fund managers had a decline in assets under management.  Investors dissatisfaction continues as they have become increasingly focused on short term performance.

The source for this article can be found here.

The Return of Funds of Hedge Funds

According to the March 7th issue of Pensions & Investments, investors are using fund of fund managers to manage their hedge fund portfolios.  They are turning to the largest managers such as BlackRock Inc., Blackstone Alternative Asset Management, Grosvenor Capital Management, Mesirow Advanced Strategies, J.P. Morgan Alternative Asset Management, Pacific Alternative Asset Management and UBS Hedge Fund Solutions.  There are several reasons for this change from the trend of directly investing in hedge funds:

• Internally managed portfolios have earned poor returns or are getting fund of hedge fund returns
• Investors are outsourcing their allocation models for niche, specialty or capacity constrained portfolios
• Florida State Board of Administration investing $300 million in the commodity trading advisor (CTA) niche
• Investors are allocating more to their alternative investment assets and want customized solutions
• Fresno County Employees' Retirement Association is adding to its portfolio - $156 million
• Plymouth County Retirement Association is increasing its hedge fund allocation by $10-20 million
• New investors want customized solutions
• Japan Post Bank wants to allocate $10 billion by March or April
• Illinois State Universities Retirement System hired Pacific Alternative Asset Management Co. and KKR Prisma to manage $500 million

According to Joshua Levine, managing director and head of business development, of BlackRock Inc., the new investors and existing investors allocating more assets are onboarding using separate managed accounts that "offer more control, better pricing and improved transparency".  The article does note that the largest, most well known fund of fund managers are receiving most of the new business.  Medium and small sized managers are not part of this trend.

Hedge Funds Replace Mutual Funds

Hedge fund and fund of funds managers have been adding long-only as an investment strategy according to an article in the December 23, 2013 issue of Pensions & Investments.  These include such famous names as CQS, Lansdowne Partners, Lone Pine Capital, Maverick Capital, Tiger Global Management, Viking Global Investors, Winton Capital Management, Blackstone Alternative Asset Management and the Rock Creek Group.  The new strategy has been driven by institutional investors - of which, 44% invest in long-only funds.  The interest has been fueled by several other factors:

• Institutional investors' disappointment with mutual fund returns
• Since the financial crisis of 2008, shorting securities has been underperforming as an investment 
• strategy
• Confidence in hedge fund managers as stock pickers
• Performance fees are easier for the manager to attain as they are based on returns relative to the performance of an index i.e. S&P 500

Blackstone and Rock Creek have almost $7 billion in assets under management (AUM) in the long-only strategy.  Both companies launched the strategy a few years ago.  In 2007, Blackstone used hedge fund managers to trade the long-only components of one of Blackstone's commodity indices.  In 2009, Rock Creek launched an emerging markets equity fund.  This fund has grown to $1.8 billion in AUM.

Innovations in the Fund of Hedge Funds World

The fund of fund managers that have survived the redemptions stemming from the 2008 financial crisis have updated their methods of delivering value to investors.  There were five new ways listed in the September 16th issue of Pension & Investments, Managers in Midst of Metamorphosis article.  They are:

• Hedge fund mutual funds with daily valuation and liquidity - Aurora Investment Management LLC in Chicago has launched a hedge fund mutual fund in March with $145 million in assets under management 
• Hybrid hedge fund/private equity funds of funds with 3 to 5 year lockups - Mesirow Advanced Strategies Inc. has launched opportunistic hedge fund of funds using five strategies:  corporate liquidations, European credit and structured products, secondary collateralized debt obligations, distressed non-agency retail mortgage backed securities and distressed emerging markets debt arbitrage trades.  The lockup period allows for the manager to retain cash reserves in order to take advantage of mispriced markets while allowing for the manager to hold positions during times of market stress.
• Hedge fund beta strategies to be used with alpha generating hedge fund portfolios - GAM created the hedge fund beta portfolios based on Barclays PLC risk premium indices.  They actively manage left-tail risk during market downturns of 1 to 2 standard deviations.
• New investment capabilities to create broader alternative investment boutiques - Grosvenor Capital Management LP offers customized separate managed accounts across many alternative investment strategies
• Single strategy hedge funds with concentrated positions for institutional investors 

CalPERS Reviews Hedge Fund Strategy

The California Public Employees Retirement Systems (CalPERS) is in the midst of changing its allocation strategy for its hedge fund investments.  There are $5.2 billion in assets out of a total of $254.9 billion.  As part of its total portfolio, it is not that important but the absolute dollar numbers are impressive.  They are seeking to reduce their equity exposure by investing in assets that are not correlated with long only funds, private equity and high yield bonds.  Edigio Robertiello, senior portfolio manager of absolute return strategies, has proposed the following changes:

• CalPERS will have to raise the percentage of assets allocated to hedge funds to much more than currently
• Classifying the hedge fund allocation separately from the global equities allocation
• Limiting the beta to global equity markets to 0.20 
• Setting a standard deviation target for returns to 8%

While CalPERS is considering Robertiello's recommendations, he is reviewing the current hedge fund investments and making the following changes:

• Reducing the number of hedge funds to concentrate assets in fewer strategies
• Reducing the fund of funds allocation to 15% from 29%.  Emerging fund of funds will have a 10% allocation.
• Reducing the investments in Asia and Europe to 5% from 19%
• Increasing the allocations to equity market neutral and global macro to 10% each
• Adding an allocation to event driven to 5%
• Increasing the allocation to equity long/short to 15%

Since the portfolio has underperformed its internal benchmark by 2% since it was begun, Robertiello is hoping that the changes will improve its performance.  Against this backdrop, CalPERS is evaluating whether or not passive management is more efficient than active management.

The source for this article can be accessed here.

A To Do List for Funds of Hedge Funds

In prior articles, I have noted that funds of hedge funds (FoHFs) are losing assets under management even as the assets of hedge funds have bounced to above pre-crisis levels.  The percentage of assets invested through FoHFs had fallen to 34% in 2010.  The SEI Knowledge Partnership conducted a survey of 220 institutional investors, investment consultants and FoHF managers in June 2012.  The main complaints of investors were the underperformance of FoHFs over the past three years, high fees, lack of transparency and portfolios that are correlated with other asset classes.

The research paper listed seven topics for FoHFs to address:

• Customization of reporting, portfolios (the underlying managers of a FoHF), transparency and liquidity to create complete investor solutions
• Investing in and seeding emerging managers
• Improved risk management during market collapses
• Overdiversification.  Investors are now interested in a "best ideas" portfolio.
• Creating account structures to handle investors' requirements such as separate managed accounts, derivatives, quantitative products and registered products (UCITS and mutual funds)
• Using their subject matter expertise to advise investors on manager selection, portfolio construction, asset allocation and special strategies
• Aligning the fee structure with the investor's interests such as raising the hurdle rate or charging a flat fee

To read the entire paper, the report may be accessed here.

The Future of Fund of Hedge Funds

Since the credit crisis of 2008 and the Madoff scandal, the percentage of assets being invested in hedge funds through fund of hedge funds (FOHFs) has decreased steadily to 34%.  For FOHFs to survive and thrive, they have to add enough value to justify their fees.  Two researchers at NEPC of Cambridge, MA - Kamal Suppal, CFA, Senior Research Consultant and Antolin Garza, Research Analyst - examine this issue.  The avenues to creating this value are manager selection and portfolio construction.  Portfolio construction may be executed by creating allocations for each investment strategy and finding managers to fill them or the reverse.  Find the best managers and then allocate to each strategy.  Other questions to resolve are the weights of the managers and assigning different portions to be strategic versus tactical allocations.

NEPC views the future of successful FOHFs in three forms:

1. Conservative FOHFs that protect against the downside and participate slightly on the upside.  They have "high-conviction ideas and dynamic portfolio allocations."
2. "Niche" FOHFs with tactical portfolio allocation that is used to complement the other hedge funds in the portfolio
3. Customized portfolios used to complement a portfolio

Portfolio construction rests on the investment philosophy of the FOHF and its business considerations.  For example, a philosophy would be to regard investments as the present value of future cash flows.  Business considerations include whether or not the FOHF is an asset gatherer or seeks to earn the performance  incentive fees.

Asset gatherers use strategic asset allocation as their value add.  An EDHEC study of 200 FOHFs from January 2000 to June 2007 found that 48.4% of managers added an average of 1.54% over the average return.  During the crisis timeframe of June 2007 to July 2009, 77.7% of managers added an average of 3.5%.  FOHFs using tactical asset allocation methods had more muted results.  During the calm period, 60.9% of FOHFs added 1.24% to the returns.  In the crisis period, only 30.9% added 1.86% of returns.  The downside was worse.  69.1% of FOHFs averaged losing 3.13% more than the average return.

FOHFs that use manager selection added the most value during the first period.  92.9% of FOHFs added  an average of 3.89% excess return.  During the crisis, 48.4% added 4.18%.  The remaining managers lost an average of 4.3%.  This high figure leads to the conclusion that strategic asset allocation is the safest bet.

The researchers examined more than 15 years of returns for 1,300 FOHFs in 2011 and discovered that 20% of them added value.  Of those managers selecting hedge fund managers, only 5% added value.  To find these managers, NEPC uses a "6P" process to explain the role of FOHFs in a portfolio and verify its performance.

• People - need to have well-rounded and diverse teams that knit together their knowledge and skill sets to deliver value
• Philosophy - an investment philosophy that provides managers with clarity on how to manage their portfolios in all situations
• Process - Consists of fund research, portfolio building and risk management;  need to have defined research criteria taking into account the size of the fund, specialist versus generalist advantages, different account structures, negotiating lower fees for transparency, more control and better liquidity and monitoring managers;  use diversification to reduce business and headline risk, having access to investments in different investment strategies, sectors and geographies to reduce volatility;  risk management consists of having risk mitigating strategies (global macro, commodities trading adviser, volatility arbitrage and tail risk investing), non-correlation of positions and limits on leverage.
• Performance -  absolute and relative, relative performance for a FOHF is compared against the HFRX (investible index)
• Price - fees charged should not be reduced for FOHF that add value
• Perpetuity - have stable personnel with low turnover and investors such as private clients and family offices

The source for this article can be accessed here.

If Fund of Hedge Funds Are To Thrive...

Niki Natarajan, Editor of InvestHedge, surveyed the 103 funds of hedge funds that comprise of the InvestHedge Billion Dollar Club.  61% of respondents believed that consolidation would continue over the next five years while  76% of the same firms were planning to grow their funds internally.  On June 2007, 147 funds managed $956 billion.  In October 2012, 78 funds in the club had survived the credit crisis of 2008 and they managed only $538 billion.  The top ten funds in 2007 have lost 49% in assets under management.

The club members believe that they can grow by making acquisitions of other funds of hedge funds, merging into investment banking advisory or private equity firms, creating customized portfolios and sourcing new hedge fund managers.  Deals have made the biggest headlines this year.  The Man Group is buying Financial Risk Management.  Crestline Investors is buying Lyster Watson's fund of hedge fund business.  UBP Alternative Investments is buying Nexar Capital Group.  In the pipeline are mergers between  Kenmar Group and Olympia Capital Management and Rothschile & Cie Gestion and HDF Finance.  Some examples of funds joining advisory or private equity firms are ABS Investment Management joining Evercore and  Prisma Capital Partners joining KKR.

Blackstone Alternative Asset Management is the largest fund of hedge fund manager with $41 billion in assets.  Its growth strategy is customizing portfolios, advisory work and providing seed capital to emerging hedge funds.  Since 2007, its assets under management has grown 96%.

The source for this article can be accessed here.

Fund of Hedge Funds Continue Losing Market Share

Fund of hedge funds (FOHF) are under pressure due to poor performance in 2011 and their failures of 2008 - ability to give their investors liquidity and superior due diligence.  Many funds' liquidity was negatively affected by their hedge funds' imposition of gates and side pockets for poorly performing assets.  Confidence in FoHF's due diligence capabilities were lost in the Madoff ponzi scheme.

In 2007, 43% of hedge fund assets were invested through FoHFs.  In 2010, it was down to 34% (Statistics are from Hedge Fund Research.) as more investors started making direct investments into funds.  In absolute numbers, assets under management for FoHFs are down from 2010 to 2011 - $646 billion to $620 billion - despite the uptick in hedge fund assets.

Since 2008, private banking clients have divested themselves from hedge funds.  Insurance companies and endowments are investing directly into funds and family offices are using managed accounts and pension consultants instead of FoHF.

According to Peter Laurelli, vice president, research, eVestment Alliance in the article at finalternatives.com, “To an evolving landscape of hedge fund investors, it is increasingly difficult to showcase a clear, superior value provided by funds of funds, specifically using performance comparisons over every possible sub-classification, to other methods of accessing the industry.“Fund of funds’ core strength of single investment diversification to the hedge fund industry is moving towards a niche role as larger allocators to the industry become more comfortable investing directly, or working with consultants who may already be employed for traditional portfolios.”

The source for this article can be accessed here.

Hedge Funds and ETFs

Some high profile hedge funds use ETFs (Exchange Traded Funds) and ETPs (Exchange Traded Products) as part of their investment strategy.  These luminaries include Bridgewater Associates, Eton Park Capital Management, Lone Pine Capital, Millennium Management, Oak Hill Investment Management and Paulson & Co. according to their 13-F filings with the Securities and Exchange Commission (SEC) in December 2011.  Why would these managers use these efficient and low cost securities, risking the ire of their investors who are paying them "2 and 20"?  They are used to:

• Used as a temporary investment while individual securities are picked.  They allow the manager to invest quickly in the space before establish stock specific positions.
• Invest in markets or sectors where the manager does not have the infrastructure for detailed research or specific knowledge
• Arbitrage a security
• Mask their trades by using a large ETF
• Invest based on macro opinions
• Get exposure on a sector level when individual securities' correlations are high
• ETFs have liquidity which allows managers to trade out of positions easily
• Establish a position in sectors or regions with low liquidity and buying securities is hard
• Hedge a position

Depending on the fund strategy, fund of fund managers and investment consultants view ETF usage as positive for global macro and systematic trading strategies and negative for fundamental stock pickers.  Equity long/short managers are receiving the "2 and 20" to pick securities, not to be an index fund.

Top 5 ETFs Held by Hedge Funds

• SPDR Gold Shares (GLD)
• Vanguard ETF Emerging Markets
• Market Vectors ETF Gold Miners
• Vanguard Total Bond Market ETF
• Powershares QQQ

Top 5 Shorted ETFs by Hedge Funds

• SPDR S&P 500 ETF SPY Index
• iShares Russell 2000 Index Fund IWM Index
• Energy Select Sector SPDR Fund
• Financial Select Sector SPDR Fund
• SPDR S&P Midcap 400 ETF Trust

The source for this article can be accessed here.

Investment Ideas in Real Estate Markets

As a member of the Chartered Alternative Investment Analyst (CAIA) Association, I am fortunate enough to attend various learning events.  Last week, I listened to four investment professionals about their views on the Real Estate Markets.  Real estate may be termed the original alternative asset.  They were Rod Hinze, Founder and Portfolio Manager of Keypoint Capital Management;  Richard Adler, Managing Director and Co-founder of European Investors Inc;  Michael Stratta, Investment Analyst of Aviva Investors and Scott Yetta (sic) of Cerberus RMBS Opportunity Fund at Cerberus Capital Management.  They have different viewpoints on the markets.  Hinze manages an equity long/short hedge fund.  Adler invests in REITs and directly in real estate.  Stratta manages funds of funds and private equity funds.  Cerberus has launched a fund that invests in structure finance.

Keypoint's portfolio is market neutral.  It seeks absolute return by investing in real estate related securities.  Hinze was long on several subsectors such as student housing, data centers and movie theaters.  He was short on big box retailers, toxic debt structures in mortgage REITs and the standard overvalued securities.  Last year, the real estate appeared correlated to the equity markets.  But if the subsectors were analyzed, there was much variation.  Class A malls and self-storage were up and banks were down.  Keypoint's beta or correlation to the markets ranges from 0.1 to 0.2.

On the private equity side, Stratta is seeing a continuation of a trend for better liquidity terms for investors.  The preference is for an open-ended fund with quarterly availability for redemptions.  The classic closed-end fund with a ten year lockup is losing its popularity as more investors are looking for yield and dividends; not for appreciation.  Stratta covers the Americas and has investments in Brazil (Sao Paolo and Rio de Janeiro).  He is already looking at opportunities in what he terms the next emerging markets:  Panama, Peru, the Dominican Republic and Colombia.  Canada is divided into two parts:  Vancouver and everywhere else.  Asian banks control most of the real estate transactions in Vancouver.  Other banks cannot crack the market.

European Investors Inc's regional allocations are:  overweight in Asia, underweight the US and standard weighting for Europe.  Adler invests in REITs and real estate.  They have a portfolio of $1.5 billion in direct investments.  He spoke extensively about the increased volatility and correlation to financial stocks of REITs.  Due to the new ETFs on REIT indices, electronic arbitrage trading is causing large market moves in the same manner as the equity markets.  Regarding investment ideas, he is positive on Thailand, the Philippines, Turkey, Israel and Brazil because the general or macro conditions are favorable.  Mortgage REITs, such as Annaly Capital Management, have a 15% interest rate.  He expects that to retreat to the upper single digits - which is sustainable over the long term.  There is a also a new REIT asset class with the single family house rental as the underlying.  These homes may be a straight lease or lease to buy.  In five years, there are projected to be two to three million homes in this category.  The expected returns for this investment is 8%.  The first deal in this REIT was in April 2011 in a deal co-sponsored by Fannie Mae and Credit Suisse.

The final speaker from Cerberus Capital had recently launched a $1 billion hedge fund focused on Residential Mortgage Back Securities (RMBS).  For a fund manager, he gave a surprising amount of detail to non-investors.  He split his investment universe into agency and non-agency securities which are a $10 trillion market.  Agency securities are created by government sponsored entities such as Ginnie Mae, Fannie Mae and Freddie Mac.  Their main risk is pre-payment of loans and mortgages.  Non-agency securities have credit and interest rate risks.  The fund managers analyze RMBS based on a number of factors:

• Yield is analyzed based on the behavior of the borrowers.  Of the universe of borrowers within an RMBS, they look at how many will pre-pay (i.e. re-finance), pay late, get loan modifications or default.   Scott is seeing value in borrowers with hybrid loans such as the 5/1 homeowner loan where the first five years are fixed rate and then the rate floats.  The most interesting borrowers are two to three years into the floating rate period.  They are pre-paying their loans by re-financing into fixed rate loans at historically low rates.  Many of these loans may be found in a mezzanine tranche.
• The recovery value of houses liquidations is viewed on a state by state basis because of differing state foreclosure laws.  A house in California can be foreclosed without going through court approval;  not so in New York and Florida.  The shorter the period, the higher the rate.
• Built in expectations that there will be another 10% drop in real estate
• Investors need conservative assumptions on the above three factors as a cushion for credit risk.  2011 returns were down because of two macro events:  the Eurozone crisis and the delay in the selling of Maiden Lane II, a huge loan portfolio of the Federal Reserve Bank of New York.  In the third and fourth quarters, funds hedged against a drop in RMBS - anticipating that Maiden Lane II would cause an oversupply of this product.  They hedged using residential indices such as the ABX and Prime Index, commercial index (CMBX) and high yield/investment grade indices.  Paying for the loss protection caused real estate hedge funds to underperform the market.
• Documentation and loan servicers are understaffed and large institutions are selling their units
• Government policy directly affects agency securities.  Cerberus has some insight into the federal government by having Dan Quayle and Jack Snow as staff and by owning GMAC.

Thank you, CAIA, for organizing this great event.

Most Popular Hedge Funds for Institutions

Pension & Investments recently compiled a list of 35 hedge fund and 10 fund of fund managers that had the largest capital inflows in 2011. To join the club, the funds had to have at least an additional $100 million. Bear in mind that these investments were made by institutional investors (pension funds, endowments, foundations and sovereign wealth funds) and are only part of the entire investment picture. Many new investments and the assets invested are not reported. As an example, BlueMountain Capital Management garnered $323 million according to the study but, according to its founder and president, had $1 billion from institutional investors.

The most popular hedge fund strategies were credit/fixed income, multi-strategy, long/short, activist and global macro based on the number of funds. Based on new assets under management, multi-strategy led the way; followed by credit/fixed income, activist and long/short. Capula Investment, a multi-strategy fund, added $825 million to rank number one. Next inline were D.E. Shaw Group ($555 million), Trian Fund Management ($500), ValueAct Capital Partners ($500 million and Ascend Capital ($465 million). Other famous names lower on the list are Brevan Howard Asset Management, Carlson Capital Management, Avenue Capital Group, Och-Ziff Capital Management Group, GSO Capital Partners (a part of the Blackstone Group), Astenbeck Capital Management and Saba Capital Partners.

The fund of fund list was led by Prisma Capital Partners ($666 million), Permal Group - a subsidiary of Legg Mason ($507 million), Blackstone Alternative Asset Management ($506 million) and Pacific Alternative Asset Management ($400 million). Three funds - Prisma, Blackstone and Pacific Alternative Asset Management - are recipients of an increased allocation by Kentucky Retirement Systems ($400 million each) that vaulted them to the top of the rankings. There were three trends affecting the allocation to fund of funds. Public and corporate pension plans are increasing their investments to diversify their fixed income portfolios. Fund of funds are expecting non-US pension plans to invest in alternative assets.

The source for this article can be accessed here.

Global Macro: A Star Performer In Times of Market Stress

In the December 2011 issue of the Hedge Fund Journal, Mark van der Zwan, portfolio manager, and Radha Thillainatesan, investment analyst, of the Morgan Stanley Alternative Investment Partners Fund of Hedge Funds wrote a research paper on the Global Macro strategy. During times of stress (current credit crisis, technology bubble and Russian default of 1998), it has one of the top two returns for hedge fund strategies. Global macros returned 4.7% and 15.5% (as defined by the HFRI Macro Index) for the credit crisis and technology bubble while the Standard & Poor's 500 returned -51% and -44.7% respectively. No numbers were given for the Russian default. Correlation of returns also drop during these times. In the credit crisis, the statistic is -17%.

Obviously, investors should use global macro funds to diversify their assets from the standard equity and fixed income funds. In the current volatile markets, investors should think about the high volatility of returns for the strategy, the wide variety of macro strategies and the subsequent wide variety of returns. As macro strategies lose their investing edge, managers are specializing in their investment strategies either through asset class (commodities, currencies, etc.), technical trading signals or length of holding (as measured within the same trading day). This causes the wide range of strategies and returns. With proper research, the global macro portfolio can be diversified and perform well during market crises.

The article can be accessed here.

I would like to thank the Chartered Alternative Investment Association (CAIA) for providing a free subscription to the Hedge Fund Journal.

An Interview with KStone Partners

Finalternatives.com held a recent interview with Joseph Marren, President and CEO of KStone Partners, a fund of fund manager that has three funds with $125 million in assets under management (AUM).  Their returns are +20% for 2009, +8% in 2010 and in positive territory in 2011.  KStone offers access to diversified alternative investments to institutional and high net worth investors.  They use 25 to 33 managers in their funds that have a low correlation to the equity and debt markets.  They find their managers through their networks mainly.

He believes that there will also be a role for a fund of funds manager.  Small and medium institutional investors need them to provide access to a diversified hedge fund portfolio.  They do not have the scale (in AUM).  As for large institutions, the current trend is self-management of portfolios.  Marren thinks that investors will discover that they do not have the personnel to create an alternative investments portfolio and will return to the fund of funds model.

Funds of Hedge Funds: 1 in 20 Deliver Alpha

In a research report by Benoit Dewaele and Hugues Pirotte of the Brussels Free University in Belgium and Nils Tuchschmid and Erik Wallerstein of the Geneva School of Business Administration, fees associated with fund of funds wipe out almost all alpha for investors.  Alpha is defined as risk-adjusted investment gains.  Only 22% of fund of funds create any alpha.  Of these funds, one in twenty delivered alpha by picking the best performing funds.  The remainder was delivered through hedge fund indices.

50% of fund of fund managers underperformed the indices.  Hedge funds are not adding value over the past thirty years.  The average fund has a lower return than a stock market index fund.  The analysis was done on 1,300 fund of funds from 1994 to 2009.

The report's title is Assessing the Performance of Funds of Hedge Funds.

The source for this article can be accessed here.

Hedge Funds Struggling in First Half of 2011

Hedge fund indices have underperformed the regular indices year-to-date through June 30th.  The S&P 500 is up 6%;  the MSCI World Index is up 5.62%; and the Barclays Capital Aggregate Bond Index is up 2.72%.  Meanwhile, for the same period of time, the Dow Jones Credit Suisse Hedge Fund Index is up 1.65% and the HFRI Fund of Funds Composite Index is down 0.33%.  Despite this, investors added $29.5 billion into hedge funds in the second quarter.  Of all the investment strategies, Global Macro has had the most difficult year as there have been no market trends in the current economic environment as it lurches from crisis to crisis.  However, this message is not coming across to the investors as 64% of them will seek to invest in these underperforming funds, according to a survey of 2,700 institutional investors and hedge fund managers by Prequin Research.

The source for this article can be accessed here.

Small Hedge Funds Are Thriving

A survey by Citi Prime Finance found that hedge funds with $1 to $5 billion in assets under management grew the largest in 2010.  This can be traced back to performance.  Smaller funds outperform the giants by 1.88% on an annual basis.  Large institutional investors such as pension and sovereign wealth funds still allocate to the larger hedge funds because they do not want to be the largest investor in a smaller fund.

Funds of funds allocations from hedge fund investors have fallen to 33% from 45% since 2006.  Meanwhile, direct investments in hedge funds have risen to 66% from 55%.  Funds of funds are invested in too many funds and have an extra layer of fees.

The source for the article can be accessed here.

Trends in Funds of Hedge Funds

Charles Gubert of www.cooconnect.com opined funds of hedge funds (FoHFs) need to respond to investors requests for managed accounts, liquidity and transparency.  Last month, Preqin, a hedge fund industry research firm, said that 40% of institutions would invest directly into hedge funds instead of using the FoHF vehicle.  Another trend seen in the FoHF universe is the offering of specialty strategies to accommodate a new investment thesis.

So far in 2011 FoHFs have underperformed hedge funds - 0.66% versus 1.92% according to HFRI indices.

The source for this article can be found here.

Alternative Investments: Changes in Portfolio Allocation

A survey of 55 investment consultants handling $10.4 trillion of assets under management was conducted by Casey Quirk and eVestment Alliance.  One of the conclusions was that alternative assets would become part of the mainstream of a portfolio - an idea recently presented by Mark Yusko of Morgan Creek Capital Management.  Instead of being in a separate alternatives bucket, they would part of an asset class.  The investor allocation asset classes will be:  illiquid investments, liquid alpha, real assets, equity, fixed income and cash.

According to the survey, the buyside will have to adapt.  The firms that bring the most value to their clients would have non-correlated investments, both traditional and alternative funds and a robust innovation/product development pipeline.  Looking at Quirk's chart, hedge funds, fund of funds, emerging markets equity and real estate are poised to grow in 2011.  Direct investment in hedge funds is favored by large institutions.  Smaller investors use fund of funds.

The source for this article is Simon Kerr's Hedge Fund blog, a blog that I have referred to in past articles.

Smaller Hedge Funds Are Attracting Investors

Emerging hedge funds are attracting interest from pension fund investors such as the California Public Employees' Retirement System (CalPERS) and the New Jersey Division of Investment.  Smaller hedge funds that manage less than $50 million returned 13.1% annually for the last 15 years through 2010.  Compare this figure with an 11.62% return for funds with more than $1 billion in assets under management and 10.23% return for the HFRI Fund Weighted Composite Index.  Pension funds are also mimicking the hedge fund of funds business model by seeding these new funds and getting a share of their profits.  So, they are getting investment returns and participating in the incentive fees.  Seeders invest for the long term and usually have a two to three year lockup on their capital.

The largest hedge funds receive about 90% of the investment dollars.  Many investors are worried about capacity issues as they swell in assets under management.  After 2010, the more successful funds have recovered from the credit crisis and are closing their funds to new investors.

Some firms that specialize in seeding fund of funds and investing in emerging funds are Busara Advisors, Reservoir Capital Management, Protege Partners, Blackstone Alternative Asset Management and Larch Lane Advisors.

The source for this article can be accessed here.