By Niki Natarajan
"Alice comes upon a mushroom and sitting on it is a blue
caterpillar smoking a hookah. The caterpillar questions Alice
and she admits to her current identity crisis." - Lewis
Carroll's 1865 novel Alice's Adventures in Wonderland.
I wonder if perhaps Lewis Carroll's hookah-smoking
caterpillar might not also be referring to the identity crisis
currently suffered by the beleaguered funds of hedge funds that
are being battered down on fees by underfunded defined benefit
pension funds - as well as struggling (for the most part) to
raise assets as institutions go direct.
According to a new report from Towers Watson, UK
institutional pension fund assets hit an all-time high of $2.7
trillion in 2012 - having grown 5% during the year and more
than doubling in the past decade.
The report also found that in the past decade these
investors have, on average, increased their exposure to
alternative assets to an average of 17% from 3%. Given the
sophistication of the US institutional market, it is safe to
assume that a similar trend is happening across the Pond.
Globally, OECD countries had some $20.1 trillion in pension
fund assets in 2011.
"So what is the problem?" the blue caterpillar would
probably ask in a short terse tone. The answer lies primarily
in zero interest rates - and the subsequent lack of volatility
- that has reduced the hedge fund investing industry to the
equivalent of the dodo's Caucus-Race, with everyone running
around in a circle and there seemingly being no clear winner in
terms of assets or direction.
So why is gathering assets proving so hard for some? If
Arden Asset Management's recent adventure in America's mutual
fund land is more than just a fantasy, then the US may offer
Instead of tapping the underfunded, shrinking defined
benefit pensions market, what about finding a way to mine a
rich and relatively untapped source of assets that is actually
Retail investors, or at least the higher net worth stratum
that is catered to by the advisory wrap businesses of the
mutual fund giants, are still pensioners in waiting. It seems
that Arden founder Averell Mortimer and the underlying hedge
funds such as Babson, Chilton, CQS and York that have followed
him down Alice's rabbit hole have discovered the curious hall
with many locked doors of all sizes - behind which are hidden
pots of assets that require alternative thinking to access.
Through one such door, Arden has found the attractive garden
and the drink that allows it to shrink (in terms of liquidity)
to comply with 40 Act rules - as well as the cake, which will
cause it to grow to a tremendous size of $740 million.
Until now, only 30 FoHFs have ventured down the 40 Act
rabbit hole but few seem to have found Arden's garden, judging
by the sluggish growth of 14% for the year ending 31 March 2012
(InvestHedge, December 2012).
In the US, which has some $13 trillion in mutual funds that
underpin the US savings and defined contribution market, there
are very few appropriately constructed mutual funds investing
in alternative assets.
Yet despite this lack of product, McKinsey & Company
says that retail alternative assets and strategies such as
commodities, long/short products and market-neutral strategies
have grown by 21% annually since 2005 and now stand at $700
And with 70 million baby boomers set to retire with
insufficient funds in their retirement pots, the likelihood for
a percentage of an additional potential $10 trillion or so to
also be invested into alternative mutual funds seems like a
real possibility as those born from 1948 onwards look for ways
to supplement their pensions.
So how can hedge fund investors hoping to taste a slice of
the mutual fund pie find the key that will open the right door?
"Before crawling away, the caterpillar tells Alice that one
side of the mushroom will make her taller and the other side
will make her shorter."
Does he mean that a mutual fund may seem small but has the
potential to grow large in terms of fees and assets, whereas a
defined benefit mandate may start large but not grow or even
earn the fees to pay the bills?
When heading off down the rabbit hole, as Alice learned, be
careful of what you eat and drink and who you share it with.
Finding the right partner is key, because like the Cheshire cat
- a cat without a grin but never a grin without a cat - who has
ever seen assets without a fund?