By Susan Barreto
The end goal is alpha, independence and investment returns for full funding of pensions, university projects and grants. For a growing number of pension funds this means using existing fund of hedge fund (FoHF) managers to create dynamic portfolios that will have to stand the test of time and ultimately end their relationship with funds of funds.
These FoHF ‘ghost’ portfolios are being built by firms such as Grosvenor, GAM and K2. Essentially, knowing that a client is no longer interested in a commingled fund, they help to choose the direct managers to keep in the portfolio, leaving behind a spectre of their expertise. Smaller public pension funds, such as Colorado Fire and Police and Oklahoma Police Pension, are moving into single-manager names and demolishing the traditional role of FoHFs as an easy one-stop entry point into hedge funds.
Institutions building direct hedge fund portfolios are effectively saying that the expertise in choosing strategies, managers, portfolio weightings is a commoditised business worth paying 1% of assets or less. At Oklahoma, redeeming from Attalus Capital resulted in savings of $1 million in fees and costs. Oklahoma found the decision to ask its incumbent long/short equity FoHF, Grosvenor Capital Management, to assist it in its plan to allocate directly a relatively easy one.
Meanwhile in Colorado, working closely with K2 and GAM, the pension fund was able to establish niche long/short equity portfolios and to source global macro managers. At the same time, the fund is using Albourne to aid in manager due diligence.
Essentially, FoHFs are victims of circumstance to some degree. Following Madoff, a number of FoHFs had to battle both poor public image and poor returns. According to the prevailing public relations spin, choosing hedge funds did not require any rare or exceptional talent. The stage was set for a new, seemingly more cost-effective and less controversial way to allocate to hedge funds.
In the short term at least, the result of this ghost FoHF protocol is that investors are able to hold on to their former FoHF holdings under the employ of a specialist consultant and/or FoHF adviser. So instead of a large number of institutional FoHFs products (offered by firms like those in the InvestHedge Billion Dollar Club, for instance) the future seems to point to just more than a handful of consultant/FoHF adviser-driven portfolio types created in cookie-cutter fashion over time.
There is no concrete evidence yet for increased performance of consultant-driven portfolios over the long term or that FoHFs can earn back their fees in the short term. Outperformance with consultant-led portfolios is a bet though that many pensions are willing to make in the US, while UK pension schemes are likely to follow suit as consultants call FoHFs to account for poor 2012 performance.
In the UK, the Avon Pension Fund will decide at its next committee meeting whether to fire Man for underperformance. Its four fund of hedge fund managers – Signet, Stenham, Gottex and Man – have produced negative relative returns over three years, and hence did not meet their three-year target performance.
Should these ghost FoHF portfolios lead to a wholesale scrapping of distinct hedge fund allocations is also unclear. Certainly if these FoHF ghost programmes do well it will not be the FoHF taking the credit for a previous allocation decision, as many report to specialist consultants. These consultants seem to be eager to offer hedge fund advisory services on a scale larger than what the FoHF industry ever handled for institutional investors.
It leads one to wonder, though, whether FoHFs really hope that their ‘ghost’ portfolios will be haunting enough to win back the business they have already lost.