Multi-managers: Solving tomorrow’s problems

By Jack Inglis, CEO, AIMA

Published: 30 June 2016

For some activities unless you really know what you are doing then the D.I.Y. approach might, in the longer term, cost you more. Hedge fund investing is still, at least in some areas, one such industry, even if the focus by both investors and the media continues to be on the cost of hedge funds and rather than the value they can add.   

On 19 April 2016, AIMA hosted its first dedicated roundtable where a cross section of professional multi-manager hedge fund selectors, once collectively categorised as funds of hedge funds (FoHFs), discussed the challenges they are facing as they transition from intermediaries that provided access into alternative asset managers that offer solutions.

The hedge fund multi-manager industry is very different today from the one that started in November 1969 with Leverage Capital Holdings. The fund was launched to offer diversified access to hedge fund talent at a time when private investors had to put a minimum of $1 million in per hedge fund. Multi-manager hedge fund assets went on to peak at roughly $1.2 trillion in June 2008. 

Today, is it hard to quantify the size of the industry as family and private investment offices run multi-manager hedge fund portfolios, cross holdings are common (leading to double counting) and some allocators include bespoke and customised hedge fund mandates in their reported multi-manager assets under management. 

The most recent InvestHedge Billion Dollar Club [1] puts FoHF industry assets at $671 billion, equivalent to managing 25% of hedge fund industry’s money, while other surveys suggest that pure commingled assets are more likely to be around 12%. What has happened is that the industry is continuing to polarise between the very large FoHFs and the smaller ones, with the top 10 largest (by assets) making up 43% of the multi-manager industry.   

Whichever format, commingled or customised/bespoke, the days of buying a database and ‘plonking’ hedge funds in an alternatives bucket within a portfolio are over. Those investors that see hedge funds as a single and largely interchangeable universe may be those that are disappointed with hedge funds. 

Looking at the InvestHedge performance league tables for 2015, [2] FoHFs on average were flat and yet a cursory glance at the general multi-strategy FoHF category shows a number of multi-managers were up more than 7% for the year and in strategy-specific FoHF categories double digit returns were prominent. 

What this shows is that just as there is performance dispersion among underlying managers, so too not all FoHFs are the same. Additionally, because the FoHF indices do not typically include the returns of customised/bespoke hedge fund portfolios, which often have higher returns, to the outside world FoHF returns may appear to be lagging especially when compared to the single manager hedge fund composites. 

Allocating to hedge funds today is about isolating diversified streams of idiosyncratic or uncorrelated returns, which only truly talented managers, generally but not exclusively hedge funds, can still find. It may be that some of the best returns can be found in smaller, newer managers, frontier markets or capacity constrained strategies that are not worth researching by allocators trying to place a few billion at a time. Picking hedge funds in corners of the investment landscape such as these is not a trivial exercise. It is a skill that many of the multi-managers have honed over at least one, sometimes two decades.  

Helping an investor understand how individual multi-manager businesses are run can also help to explain why FoHFs need to charge fees: operational due diligence, investor relations, research, legal, compliance, not to mention the increasing regulatory burden the marketing regulations add to the mix. 

Today it is not the size of the team that counts, but the ability to solve an investor’s problem. With regulations, low rates and volatile equity markets, returns are just as important as they were before, but costs (or more accurately value for money) and risk budgets and capital usage ratios need to be taken into consideration. The adviser, which can understand the investor’s problem and then find the appropriate ‘tools’ to solve them, will be the winner in the alternative investments allocation game. Having the ability to identify truly idiosyncratic or uncorrelated managers, and charge accordingly, is likely to make a multi-manager a new beneficiary of assets in the new environment.

Consultant overlap was one of the key areas of concern among the FoHFs gathered at the recent AIMA round table. Some consultants, though not all, now offer their own pooled multi-manager hedge fund portfolios on which they can earn basis points on assets under management rather than a one off consulting fee to ‘outsource’ assets.   

There is a trend in asset management in general towards fiduciary mandates being offered without competitive tender, according to KPMG’s Fiduciary Management Market Survey. [3] In 2014, 75% of new mandates were awarded without a fully competitive tender, KPMG found. Ironically, in this competitive environment some multi-managers are ‘giving away’ their research and offering hedge fund allocation advice/consultancy to retain market share and clients. 

The partial disintermediation of the FoHF industry was inevitable as institutional investors became more sophisticated but multi-managers will continue to find new ways to add value: product or service related mergers; co-investing; taking minority stakes in the GPS; offering managed accounts; funds of one; portfolio solutions; liquid alternatives; or thematic funds are different ways traditional hedge fund selectors are re-defining their offerings. 

The FoHF industry should not be written off. It is worth noting that the first hedge fund A.W. Jones & Co., founded by Alfred Winslow Jones in 1949, has evolved into a fund of external managers that is still in operation in this structure seven decades later. There is a value to multi-manager hedge fund investing for those that understand how to truly look at costs and recognize the skillset. Today, however, using multi-managers is less about the ‘3Ds: diversification, due diligence and deniability and perhaps more about the 3C’s: collaboration, (portfolio) construction and creativity.

 

[1] InvestHedge March 2016 Volume 15 Issue 5

[2] InvestHedge February 2016 Volume 15 Issue 4

[3] https://assets.kpmg.com/content/dam/kpmg/pdf/2015/12/fiduciary-management-market-survey-2015.pdf