Key Takeaways
- • Don Steinbrugge, managing member of third-party marketing firm Agecroft Partners, argues that funds of hedge funds (FoHFs) can still raise assets despite four consecutive years of net redemptions by identifying a niche across strategy focus, fund structure, or investor segment.
- • With more than 2,000 funds of hedge funds competing for capital, Agecroft expects redemptions to continue in 2012, with the largest FoHFs most exposed as pension funds bypass them to save fees.
- • Global macro/CTA assets rose from USD288bn to USD433bn, according to HFR, as investors sought downside protection and low correlation to other strategies.
- • Managed account platforms, UCITS and '40 Act funds have drawn disproportionate flows as first movers in new structures.
- • Pension funds are adopting a hub-and-spoke model, using a core allocation to a large FoHF and niche FoHFs as satellites.
Summary
Don Steinbrugge, managing member of third-party marketing firm Agecroft Partners, says that in a highly competitive fund of funds marketplace with more than 2,000 participants, firms can still raise assets successfully by identifying a market niche in one of three areas: strategy focus, fund structure and investor segment. The sector has experienced net redemptions four years running, and Agecroft expects that trend to continue in 2012, though some FoHFs have thrived by specializing.
Flows into the FoHF industry over the past decade have come largely from large institutional investors, who historically valued the perceived security of a firm's size, brand and infrastructure over pure performance. Many institutions diversified across several large FoHFs without recognizing that those firms often shared significant underlying manager overlap, and performance at some large organizations has fallen short of expectations. Two trends are now reshaping the segment. Multi-billion-dollar pension funds are moving from multistrategy FoHFs to direct investment with funds, often with a hedge fund consultant's help, to save fees. This is the primary reason FoHF assets have declined, though it mainly affects the largest FoHFs. The second trend is a hub-and-spoke approach, in which a core allocation goes to a large FoHF and satellite allocations go to niche FoHFs that can also serve as best-of-breed managers elsewhere in institutional portfolios. Agecroft expects this to shift a larger share of assets toward mid-sized firms, while most pension funds will continue to access hedge funds through FoHFs and strong retail inflows are anticipated.
On strategy focus, Agecroft cites global macro/CTA, where assets rose from USD288bn to USD433bn by the end of September 2011 according to HFR, as investors sought tail-risk protection and low correlation after the 2008 and early 2009 drawdowns. Commodities benefit from inflation concerns tied to dollar weakness and rising demand from China and India. Seeder/accelerator funds attract smaller managers who need capital to reach the USD100m minimum many investors require, in exchange for performance and a quasi-equity stake. Emerging and mid-sized managers are also gaining attention, and Agecroft points to niches such as long/short equity, credit and emerging markets.
On fund structure, first movers have captured flows. Managed account platforms have expanded sharply since the Madoff fraud and 2008 gates, offering daily liquidity, transparency and risk analytics. UCITS funds have grown in popularity since 2008 with daily liquidity and low minimums. The '40 Act mutual funds, sold through large broker-dealers, have raised billions, though new entrants are increasing rapidly. Insurance-wrapped funds allow US taxable investors to defer tax, and fund-of-one feeder vehicles give high net worth investors access to large hedge funds. On investor segment, Agecroft highlights insurance companies, which are raising hedge fund allocations as falling interest rates depress returns on their portfolios; regional and local-network focus; and relationship-driven access to retail financial advisors, where FoHFs must win approval on each brokerage's list. Agecroft concludes that unless a firm is among the largest or has a top track record, it must find a niche to differentiate itself.
Flows into the FoHF industry over the past decade have come largely from large institutional investors, who historically valued the perceived security of a firm's size, brand and infrastructure over pure performance. Many institutions diversified across several large FoHFs without recognizing that those firms often shared significant underlying manager overlap, and performance at some large organizations has fallen short of expectations. Two trends are now reshaping the segment. Multi-billion-dollar pension funds are moving from multistrategy FoHFs to direct investment with funds, often with a hedge fund consultant's help, to save fees. This is the primary reason FoHF assets have declined, though it mainly affects the largest FoHFs. The second trend is a hub-and-spoke approach, in which a core allocation goes to a large FoHF and satellite allocations go to niche FoHFs that can also serve as best-of-breed managers elsewhere in institutional portfolios. Agecroft expects this to shift a larger share of assets toward mid-sized firms, while most pension funds will continue to access hedge funds through FoHFs and strong retail inflows are anticipated.
On strategy focus, Agecroft cites global macro/CTA, where assets rose from USD288bn to USD433bn by the end of September 2011 according to HFR, as investors sought tail-risk protection and low correlation after the 2008 and early 2009 drawdowns. Commodities benefit from inflation concerns tied to dollar weakness and rising demand from China and India. Seeder/accelerator funds attract smaller managers who need capital to reach the USD100m minimum many investors require, in exchange for performance and a quasi-equity stake. Emerging and mid-sized managers are also gaining attention, and Agecroft points to niches such as long/short equity, credit and emerging markets.
On fund structure, first movers have captured flows. Managed account platforms have expanded sharply since the Madoff fraud and 2008 gates, offering daily liquidity, transparency and risk analytics. UCITS funds have grown in popularity since 2008 with daily liquidity and low minimums. The '40 Act mutual funds, sold through large broker-dealers, have raised billions, though new entrants are increasing rapidly. Insurance-wrapped funds allow US taxable investors to defer tax, and fund-of-one feeder vehicles give high net worth investors access to large hedge funds. On investor segment, Agecroft highlights insurance companies, which are raising hedge fund allocations as falling interest rates depress returns on their portfolios; regional and local-network focus; and relationship-driven access to retail financial advisors, where FoHFs must win approval on each brokerage's list. Agecroft concludes that unless a firm is among the largest or has a top track record, it must find a niche to differentiate itself.
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