In truth few investors genuinely go it alone when allocating directly to hedge funds. The majority still use third-party advisers such as traditional investment consultants. On the surface, their relative cost looks compelling.
Based on an investor survey, Barclays Prime Services calculated the comparative fees of discretionary services provided by funds of funds of around 100 basis points (based on an average reported 0.8% management fee and 5% performance fee assuming a 5% return), compared to 40 basis points for consultants.
“Investors who have moved away from funds of funds and simply bought hedge funds off their investment consultants’ buy lists have not done so well,” argues Chris Jones, head of public markets and alternatives at bfinance. “Consultants are not motivated enough to look down the size spectrum. Nobody ever got fired for buying IBM. This is not the right route to benefit from hedge funds. It tends to be limited to large managers, some of which are past their prime.”
From weakness to strength
The outflows funds of funds have suffered sparked an evolution towards customised mandates in a partnership approach, which has begun to reap rewards, particularly in the US. According to research from Preqin, North American funds of hedge funds, who are leading the evolution, grew assets by 5.5% during 2013 to $536bn. “The changing shape of the funds of funds industry is leading investors back,” says Amy Bensted, head of hedge fund products at Preqin, who expects the trend to continue during 2014, especially in the US.
One of the key advantages of the customised approach is the ability to monitor portfolio level exposures and risk and adapt those to fit investors’ broader portfolio characteristics. This customisation is not reserved for only the largest institutions.
“Most institutions should be able to access a customised discretionary or advisory offering at relatively low minimums, typically around $25m-$50m,” says Andrew Malik, executive director in the hedge fund solutions group at Morgan Stanley Alternative Investment Partners. “In terms of the cost and quality of these services between the various providers, there is a wide range and the old adage of ‘you get what you pay for’ usually applies.”
Focus on fees
Yet, disappointment continues to plague investors in funds of funds. Institutional investors and funds of funds achieved similar absolute returns for the year-to-date September 2013, according to Barclays Prime Services. Much of the anti-funds of funds feeling stems from expectations for funds of funds to generate greater returns to compensate for their higher explicit cost.
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