By Susan Barreto
Trustees it would seem are still in need of a good education on hedge fund investing. This month for instance, we provide a snapshot of the US public pension fund market that has steadily increased its allocation to hedge funds over the years. But a shift from traditional FoHF portfolios to direct single manager portfolios continues with a simple cost-cutting mindset driving trustee decisions.
But is that the right driver? Is there anything FoHFs can do to educate investment boards on what it is that they did and continue to do to add value? From my investor-biased perspective, I think these are the four key things trustees should know before deciding what to do regarding FoHFs.
Fees are just one small reason for going direct
Most trustees find it easy to rationalise that FoHFs are expensive and consulting advice is not. In going direct, trustees are effectively saying that the staff alongside an adviser (FoHF or consultant) are adequately equipped to source hedge fund talent and are willing to send staffers to various locales for due diligence trips and monitoring. Going direct has to be about an investment belief that they are choosing the best and the brightest single manager names for the next five-plus years, not a cost-cutting move. Sometimes the travel, legal and administrative costs can add up.
Advice is a many splendored thing
The choice of specialist consultants or FoHFs for advice is not a simple coin flip. Not all consultants and FoHFs are created equal in this task. While some offer up a customised approach and access to managers that may even be closed to outside investors, other firms may only have a small stable of manager names to choose from and may have limited manpower to source new talent.
The choice of retaining an existing FoHF versus a consultant is one of expertise in portfolio structuring and strategic mindset. It is also a tiered structure depending on the needs of the board and staff. Monitoring, due diligence and portfolio construction services may be added value provided by FoHFs that some consultants may not be as willing or able to provide. Transparency of services provided and managers selected for other clients as well as performance is a must for trustees.
Performance and volatility are strange bedfellows
The idea that risk-laden, volatile performance figures are only the domain of university endowments and family offices is slowly going away. The only problem is that most pension fund boards have no idea what level of volatility is acceptable for the performance they desire. In fact, the issue is rarely raised in trustee discussions regarding individual managers or strategies. While most in the hedge fund industry blame institutional investors for dampening volatility and performance in the industry, in reality some low volatility and decent performing hedge funds have snuck their way into pension programmes via FoHFs. It is just a matter of whether or not the stats have been reported in such a way that trustees can understand the real drawdown risk to their portfolio.
FoHFs are flexible
Whether or not it is structuring a ‘fund of one’, a customised portfolio or a standard commingled product, funds of funds managers have proven that they are willing to go the extra mile to compete for trustee business. They may not always say it, but many are concerned that as some consultants morph into asset managers they will no longer continue to employ them on behalf of trustees. FoHFs have proven that they are willing to negotiate and serve the needs of clients both large and small, which in the end is crucial for trustees’ evolving portfolio needs.