Hedge funds: variety is the spice of life – and survival
Before the crisis, hedge funds were not interested in retail investors, preferring to roll out the red carpet for pension funds. But today, having a variety of investors is important to fund managers.
During the crisis, many hedge funds came to regard wealthy European investors and their advisers who redeemed heavily as persona non grata. One large manager expresses his anger bluntly: “European high net worths do not seem to understand what we do. They are not necessarily welcome back.”
Globally, retail investors – broadly defined – were behind more than 80% of total crisis withdrawals from hedge funds, according to BNY Mellon.
This has since closed the door to some, even though they were the $2trn industry’s original investors.
But there are signs, as managers replenish their assets, that doors may be opening again for the non-institutional audience. This is because the main focus of many managers is on getting a mixture of high-quality investors, and not rejecting any particular kind.
The need to do this in order to stabilise funds and their businesses has arguably become greater with the growth in liquid regulated versions of their hedge funds, where investors can redeem within a fortnight, not every 75 days.
Morten Spenner, chief executive of hedge fund investor International Asset Management (IAM), says diversifying investors is important at both the single fund and fund of funds level.
IAM’s open-ended funds are mainly filled with institutional assets, but retail investors can access its fund selection skills by investing, for example, in the listed Alternative Investment Strategies listed fund.
Spenner says: “Managers understand it is important to get the right mix of the right kind of investors in their fund, not only to the benefit of themselves, but also all the investors in the fund. You do not want to rely heavily on any kind of investor.”
He has been doing the same thing – at the fund of funds level. “We have been asking hedge fund managers over the past months, for example, whether they know on what basis their investors make decisions? What happens to a fund, for example, on the day a ratings agency downgrades them?”
David Aldrich, managing director at BNY Mellon, says during the crunch many high net worths “did not have a deep enough understanding of alternative investments. Losing capital in hedge funds was a misunderstood risk”.
Roy Kuo, head of research at Dexion Capital, says it is natural for managers, especially younger ones, to have some dependency on “faster-moving investors” at the outset “as these are the types of investors who are willing to allocate to the manager early in the manager’s life.”
Being risk aware
The problem, according to Aldrich, was an over-reliance on retail money by some managers. The departure of these allocators is just one of many seminal moments managers say demonstrates why it is important to diversify. Another was endowments and foundations redeeming to finance private equity capital calls. A third was other institutional allocators withdrawing to rebalance equity holdings whose value fell further than hedge funds in 2008.
Udo Rosendahl, DWS Investments’ head of multi asset, says: “Having a broad investor base with different risk classes and different time horizons – preferably with a tendency towards longer investment horizons – stabilises a portfolio, and is key for successful fund management.”
Lisa Fridman, associate director at investor PAAMCO, says in the past, some funds were happy just to raise assets, but now managers are factoring in the stability of the capital they attracted.
She says: “It is important for hedge funds, as businesses, to understand the true investment goals and horizons of their underlying investors. Investors definitely want to understand who their co-investors are, as well as what their goals and investment horizons are. Managers are now also aware of such risks.”
Managers must also “look through” their immediate investors, to see who their end-clients are, adds Daniel Mannix, head of business development at London fund manager RWC Partners. A good fund manager also monitors when investors entered the strategy and what their expectations of it are.