The funny thing about hedge funds is that investors either love them or hate them. They're punted either as the miracle cure for investors who've lost a large slice of their investable wealth during the three-year global bear market, or another bubble waiting to burst.
Speaking at an SEI International hedge fund conference recently, Ernst & Young hedge fund expert Joel Press said: "It's an entrepreneurial industry that has its positives and its negatives. The greatest risk is comparing it with the long-only industry. In the hedge fund industry, there is a minimum of 24 investment styles and within these are numerous deviations in the way managers do it."
What makes it a difficult industry to read is that investors have to contend with capacity constraints, a lack of transparency and different types of risk to those encountered in the conventional fund management industry.
Investors have realised that love them or hate them, they cannot be ignored.
There has been growing demand from the retirement industry and hedge funds are likely to become more institutionalised. Pension funds are demanding more transparency and prefer to invest with more established hedge fund managers to reduce the business risk associated with go-it-alone managers. Also, the traditional active asset-management industry is starting to offer its own hedge fund managers, products and partnerships. In the retail sphere, progress is dogged by the difficulties in developing regulation that protects the retail investor but does not overly constrain hedge fund managers whose investment performance relies on the freedom to invest as they see fit. Fund of hedge funds have become the most popular way of gaining access to the hedge fund industry and the number of fund of hedge funds has multiplied during the past couple of years. They're attractive because they offer the pension fund investor a formalised investment process, diversification of manager and investment style risk, and usually more transparency than they would receive from a single hedge fund manager.
Investing in a fund of hedge funds reduces the specific risks associated with the hedge fund industry.
The drawbacks of investing through a fund of hedge funds are that they can be expensive and it has become almost as difficult to choose a fund of hedge funds manager as it is to identify the underlying hedge fund manager.
The better fund of hedge funds have an investment team that understands the hedge fund industry and the managers that operate within it.
SA pension fund investors have access to a wide range of offshore fund of hedge funds products. Every large institution either has an association with an international fund of hedge funds provider or has its own fund of hedge funds.
SEI Investments recently launched its fund of hedge fund offering. It has teamed up with Pacific Alternative Asset Management Company (PAAMCO). London-based global options vice-president Joe Ujobai says the most important considerations were getting access to the best managers and achieving transparency of their investments. "The easy part is hiring the managers. The hardest part is overseeing them. Until we could do it, we couldn't offer a solution."
When asked why they didn't do the job themselves and chose instead to use another manager of managers, SEI alternative investments product develoment head Stuart Ames says they wanted to use an already established expert in the field that had the infrastructure in place and was connected and respected in the hedge fund industry.
SEI offers two fund of hedge fund options: a low volatility hedge fund that is nondirectional and has lower risk and return expectations, and a medium-volatility hedge fund that is directional and has higher risk and return expectations. SEI asset allocation consultant Andrew Slater says the low-volatility hedge fund could be a substitute for fixed income and the moderate volatility fund a substitute for equity.
Liberty Ermitage also has a range of fund of hedge fund products that it's offered since 1997. The range of six fund of hedge funds includes regional long/short equity and merger arbitrage, and are run by the group's London and Jersey offices. Liberty Ermitage group and international chief investment officer Sidney Place has "received good feedback" about the products and says pension clients use them as a diversifier as part of their global offshore mix.
He says there was initial resistance, but then pension fund clients became used to it. "They started out investing in the simple merger arbitrage fund of hedge funds, where the only risk is that the transaction doesn't go ahead and they gradually built up exposure in other more complex hedge fund strategies."
Old Mutual Asset Management (OMAM), which has an association with Ivy Asset Management, has placed R1bn offshore. OMAM executive director Derrick Msibi says the aim of investing in hedge funds should be the preservation of capital and diversification of risk. "Hedge funds are excellent portfolio diversifiers due to their low correlation to other asset classes," he says. "When markets are falling, they tend to be stable and help diversify the risk."
