Co-Opting Marketing Resources for Hedge Funds - Part Two

Preqin - Building On A Database 

The previous and following articles in this series cover lead generator companies in the hedge fund business who make great efforts to explain that they are not database companies. Preqin is a database company that is trying to add some value beyond that restrictive label, so is coming from a different direction from the other two series subjects, Murano Systems and Brighton House Associates.

Preqin provides data and information on the private equity, real estate, hedge funds and infrastructure sectors. The company started in London in 2002 by making efforts to track private equity information (hence the name) – deal flow, terms, funds, and investor activity. The market intelligence gathered was turned into publications and a database. It was the investor activity that led to Preqin collecting hedge fund related information – there was a lot of overlap among the investors in private equity and hedge funds.

Preqin collated the information the investors (investing institutions, endowments and family offices) gave them into their core hedge fund product, which is a database they call Hedge Fund Investor Profiles. Most alternative investment databases that are sold to marketers are lists of potential targets for the marketer’s product.  And the usual database/list/directory does not make much effort go beyond being a database of contacts.

A contact database typically would have a cursory company profile on a list of targets i.e. North American Family offices.  This data can be found in the public domain from phone directories to websites, and the value of a contact database is that a company or person has taken the time to gather up the data and break it into specific lists or categories.  The value is in the aggregating of the data.  The company profile might have a company name, address, phone number, general area of interest, perhaps some historical information, and the name of the acknowledged head of the organisation.

A Refreshed Contact Database

The Preqin hedge fund database is different from the typical directory-like contact database because it is refreshed on an on-going basis, and carries time-sensitive information. A directory of investor names you can buy relatively cheaply on the internet is an accumulation of all the information gathered to that point – it is a snapshot of standing data and information. Some of the information will be fresh, some will be quite ancient.

Preqin have a dedicated team of analysts proactively contacting industry professionals, monitoring regulatory filings, making FOIA requests and tracking news sources to make the their data and information on all firms, investors and service providers  up to date. The analysts speak to investors at least twice a year, and try to make contact with the larger investors four times a year.

The analysts ask investors in hedge funds what their investment plans are for the next twelve months.  There are two levels of interest captured on the database - actively looking now and tracking a strategy. The information held on the Preqin database is always first-hand, and because of the contact frequency, unlikely to be more than six months old.  This is important in a couple of regards – the investment strategies sought and followed will change over time, and the staff doing the seeking and following will change. Each month around 400 database entries are updated.

Then there is the breadth. Because of the resources applied – 25 to 30 analysts in total – and the period over which data has been gathered, Preqin has a database of investors in hedge funds which is as extensive as any. A directory or list of investor names by category might run to a few hundred fund of hedge funds or pension plans. The Preqin database has 3300 investing institutions, and the firm is currently adding 500 new names a year. For example, at the moment the firm is engaged in a project to identify and contact Foundations, in the process 70-80 names are being added each month.

Of the three providers covered in this series of articles Preqin has the most finely tiered offering by price. At the top of the range is the Premium version of Preqin’s Hedge Fund Investor Profiles.  This gives complete access to all data held for $4,250 p.a. and lists the name, type of investor, background, location, assets under management, current and target allocation to hedge funds, current areas of interest by location and strategy, description of investment plans and key contacts of the investing institutions.

Only the Premium product is downloadable to Excel or the in-house CRM of the client, and can be accessed by 5 users. The Premium product contains consultant information – who works for whom. This is considered essential information in the current hedge fund marketplace as a large part of the industry’s flows are now either mediated by a consultant or advised by consultants.  So hedge fund managers looking for the bigger tickets will buy the Premium version of the Preqin Investor Profiles. As it is, about 70% of Preqin’s clients for hedge fund products take the Premium product.

The Standard Access to Preqin’s Hedge Fund Investor Profiles costs $2,150 p.a. and it enables users to search for investors by location (e.g. list all endowments and foundations in Toronto, Canada), and find investors with specific investment plans (for example, ask who is interested in investing with hedge fund of funds). Another feature is that users can view investors by firm: that is, view which Investors have previously invested with particular hedge fund managers. This can help indicate the biases and investment style of potential clients. So a pitch can be tuned to the sort of thing that the potential investor is known to like, and the fund can be differentiated from unsuccessful investments in the past in the same investment style.

The Standard Access comes with a couple of compromises compared with the Premium Access service of Preqin. The database can be interrogated but not downloaded or linked to a CRM system, and only one user can access the database at a time.  The top-tier of investors on the database can be separately purchased in the form of the Preqin Hedge Fund Investor Review, which is an annual product. The 2012 edition features profiles and analysis for the 1,000 most important investors in hedge funds worldwide, and is keenly-priced at $795. The Review contains listings of investors with a preference for the 10 most important fund strategies.

Entry Level Products

Preqin offer a couple of entry level products: the Emerging Manager Download and the Fund of Funds download, both priced at a great value $1000 one-off cost.

The Emerging Manager Download contains contact details for over 890 institutions that have expressed an interest in investing in emerging managers, making the Emerging Manager Download an excellent way of targeting the high potential investors for a smaller fund. Investors include the full array of hedge fund of funds, public pensions, endowments and family offices and foundations. This Excel download contains details on nearly 3,000 specific contacts at investing institutions including name, position, e-mail and telephone number – sufficient to ensure a new hedge fund manager can contact at least a colleague of the relevant person.

Historically funds of funds have been the biggest allocators to hedge funds and are a necessary investor base for hedge fund managers to hit to raise capital. With the Preqin Fund of Funds download of over 600 allocators the marketer or PM of a hedge fund can searched by strategy, location and typical investment size to pinpoint the firms who may be interested in their vehicle.  The Fund of Hedge Funds Excel download contains contact details, including direct phone number and email address, for more than 2,300 individuals at the 600-odd multi-managers from around the world.  As the firms listed range in size from $10 million to $60 billion they will vary from the nimble to the lumbering, but filtering of the list by individual strategy, region and typical investment preferences tags should throw up a very workable long-list of potential investors.

Preqin has also recognised the increasing influence of consultants to flows in the hedge fund industry in its product range. The Premium version of Hedge Fund Investor Profiles contains consultant information, and in addition there is a dedicated product – the Preqin Alternatives Investment Consultant Review ($695). The 2012 edition contains profiles for over 350 different investment consultancy firms.

Consultant profiles within the Review contain information on the types of services offered, asset classes covered, key financial information, direct contact information for relevant contacts and details showing which consultants are being retained by 1,560 institutional investors from around the world. The review identifies key trends in the consultant universe plus information on the market’s make-up.  Of particular relevance for owners or marketers of single manager hedge fund businesses the Review shows which firms operate a buy-list, which firms consider first-time managers, and what they look for when considering new opportunities. The Review is also relevant to investing institutions looking to benchmark their current consultants or to investors considering the services of consultants.

The other directory-like product from Preqin is the Sovereign Wealth Fund Review, which costs $595 and provides a detailed analysis of sovereign wealth funds and their activity in all different asset classes. The Review contains useful analysis plus full profiles for over 60 sovereign wealth funds worldwide. Of all investors in hedge funds SWFs are perhaps seen as the most desirable – they have stable long-term capital, are professionally managed or advised, and can write very large tickets.

The first article in this series covered lead generator Murano Systems and the next article will feature Brighton House Associates. The final part will also draw some distinctions between the three and how they are positioning themselves, and so will come back to how Preqin is trying to compete more directly with the pure lead generators.

The End is Nigh for Smaller Funds of Hedge Funds

For some time there have been questions raised about the sustainability of the business models of funds of hedge funds as a category. There is no doubt that they will continue to exist and that there will be winners as well as losers. But the rising tide of assets in the hedge fund industry is not lifting all the FoF boats. Only this week quoted hedge fund company Man Group reported minor growth in its single manager businesses and minor shrinkage in its multi-manager business (see previous article).

There are solid reasons for the changing composition of the shape of the FoFs sector, mostly related to the source of the whole industry's net flows, i.e. American investing institutions. A typical example is the Ohio Public Employees Retirement System which had had allocations with FoFs Prisma Capital and K2 Advisors LLC. In the middle of last year the Ohio System hired specialist hedge fund consultant Cliffwater LLC to provide due diligence and manager recommendations to staff on a non-discretionary basis. The existing fund of hedge funds allocations of the Ohio System will remain in place, but from that point on new allocations to hedge funds would go to single managers with consultant input. 

The new "new thing" for state plans starting from scratch in hedge funds is to do as the State of Wisconsin Investment Board has done and go straight to single manager hedge funds without an interim phase of allocating to FoFs. The Wisconsin Investment Board has taken a decision to invest directly in 15-20 single manager hedge funds.The first allocation was to Capula GRV Fund, followed by MKP Credit Fund, Claren Road Credit Fund, Ascend Wilson Fund and BlueCrest's BlueTrend. The Employees Retirement System of Texas has announced an intention to do the same - direct investment in hedge funds, in their case a 5% allocation amounting to over a billion Dollars phased in over three years.

That is, the marginal flows to the industry are being disintermediated as far as FoFs are concerned, with consultants and advisors taking a bigger role in allocations. This has been great for the business of Albourne Partners and Cliffwater and the like, but what about the funds of hedge fund businesses? How are they getting on?

Fund of Funds In Aggregate

Each year PerTrac, the hedge fund software provider, produces an analysis of the composition and size of the single-manager hedge fund and fund of hedge fund industry. The 2011 study was produced by aggregating investment data from eleven of the world’s largest alternative databases - BarclayCTA, BarclayHedge, CogentHedge, Eurekahedge Hedge Fund, Eurekahedge Fund of Funds, HedgeFund.net, Hedge Fund Research, MondoAlternative, MorningstarHedge, Tass, and TassCTA. The combined number of investments from these eleven databases was nearly 56,000 entries. Duplicate records for single-manager hedge funds, CTAs and FoFs were removed so that a single record per fund was retained in the study to create a holistic industry list.

According to PerTrac's data,  the reported AUM of funds of hedge funds were essentially unchanged  y-o-y (+0.23%) at $447bn at the end of 2011. Given the industry had a negative return of between 5 and 8% at the single manager level last year, that implies some positive flows to FoFs in aggregate. Plus, the total number of funds of funds reporting to databases at the end of 2011 was down 4.8% on 2010 at 3,388. That is there were more assets by value overseen by fewer fund of funds managers. Someone in the fund of funds sector was doing a bit better last year!

The answer to  the question "who?" is the largest funds of funds. FoFs that reported managing in excess of $1 billion were the only group to experience a positive growth in fund numbers from 2010 to 2011 as shown in graphic 1 below.

Graphic 1. Number of FoHFs by AUM Size and Percentage Change from 2010 to 2011*

*Figure excludes515 funds in 2010 and 522 funds in 2011 that did not report AUM, source:PerTrac

Taking a look at the different size categories of funds of funds in turn, there is other evidence that  the very biggest funds of hedge funds are getting bigger. The top 10 FoF management companies (as opposed to individual funds, and as covered in the PerTrac study) added assets in 2011, according to InvestHedge data. The ten largest FoF groups managed $227bn at the end of 2011, an increase of 2.6% over the start of that year, and equivalent to 50.7% of the FoF industry's assets. In addition there were 16 FoF management companies with $10bn of AUM or more at the end of 2010. There were 17 at the end of 2011. So the very large funds of funds groups were slowly growing in aggregate.

The larger funds of hedge fund companies (those managing a billion dollars or more)  have shown stability in assets recently. The InvestHedge Billion Dollar FoF Club managed $622bn of assets between them at the end of 2011, only a tad down on end-2010 levels (-0.7%).

  

The number of FoFs containing assets of $500m-$1bn shrank last year according to the PerTrac study - there were 5.9% fewer of them by the end of 2011 than at the beginning of the year, but that size category is not where the industry squeeze is most evident. More than one-in-seven of the FOFs sized between a quarter and half a billion dollars in AUM closed down last year. It is in this size band that numbers of funds of hedge funds are shrinking most. 

This has been a long time coming - the demise of the smaller fund of hedge funds was prophesised nearly ten years ago. Very few of the mid-tier FoFs benefited from the growth of the hedge fund industry through institutional flows in the period 2003-2008. But that is not the same as saying the circumstances forced smaller FoFs out of business - they just did not grow much.  

In the period since the Credit Crunch institutional investors have completely dominated the capital inflows to the hedge fund industry. And they go big for their suppliers. HNWI investors were a major source of redemptions in the industry in 2008-9, and there have been few-to-no net flows to the industry from HNWIs in the last two years or so. It was the HNWI that was historically prepared to invest through the smaller fund of hedge fund. So in aggregate the smaller FoF experienced, say, a 35% drop in capital because of redemptions and capital losses in 2008, and little or no recovery in assets since. 

So while 47% of the funds of hedge funds managing $1bn or more experienced positive inflows last year, their smaller bretheren have seen the industry tide of capital go out and not come back again. Most modest-sized FoF managers will be running a business with the same level of income as seen in 2004-5 with the cost structure of 2012. That is not sustainable.

Reaction To Conditions - M&A

Hence the corporate activity in the fund of funds sector. For example, Nexar Capital Group was founded to pursue a roll-up strategy amongst funds of funds, and bought Allianz's fund of hedge funds business in 2010 and Caledonia Investment's Ermitage fund of funds business last year. Nexar itself agreed to be bought by UBP at the beginning of March this year. Other FoF takeovers in the last year include William Blair's acquisition of most of Guidance Capital's assets under management; Athena Capital Advisors acquired Stonehorse Capital Management; and Cantor Fitzgerald started its planned expansion into hedge funds with the acquisition of Cadogan Management. Other forms of deal seen in the last year, apart from complete takeover, have been merger and stake sale. Evercore Partners bought a large minority stake in ABS Investment Management, the $3.5 billion fund of hedge funds. The  merger between Gorelick Brothers Capital and Access Fund Management may have been defensive as the combined entity  had only $100m under management when the deal was announced.

A dealer in second-hand hedge fund assets said this week that the wind-down of some fund of hedge fund businesses has given his own business a fillip. "I see another 18 months of funds of funds mergers and acquisitions. It is great for me because it throws up holdings in companies and funds to be disposed of - there are a lot of buyers for these sorts of assets out there," he said.  "But there is a limited window for this activity, and we are in it now." What has he seen as the driver? "The funds of funds business is dying at the lower level."

 

Related articles on this site:
Hedge Fund Takeovers - Martin Currie and Schroders Acquire (June 2010)

Race for FoF Acquisitions Starts with Thames River Capital (April 2010) 

Fund of Hedge Funds Consolidation: The gun has been fired (April 2010) 

Podcast 1 - Hedge Fund M&A (Oct 2009)

Update on Reuters:
New York-based Arden has won a mandate to act as Massachusetts' so-called transition manager as the $50 billion state pension fund shifts money away from hedge funds of funds directly into a select number of hedge funds. (link, 10th May 2012)

Hedge Fund Risk Management is “A Work in Progress”

By Simon Kerr

For a long period I was unable to carry on reading SEI’s fifth annual global survey of institutional hedge fund investors beyond this summary point: “RISK MANAGEMENT IS A WORK IN PROGRESS. Only one in five of those we polled agreed that “most hedge funds do a good job of risk management.” ” The view embedded is a strong challenge to the proposition offered by those who run hedge funds.

In concept hedge funds do what they are supposed to because the managers are able to turn a fecund source of alpha into an attractive return series through an appropriate risk management framework. It is feasible to have an outstanding insight into companies/stocks/markets that enables a manager to run with an okay risk framework to produce the required return, but is extremely unusual, and, from experience, cannot be relied on to grind out returns. Rather a good risk management approach and processes are sine qua non for a successful hedge fund.

So the respondents in the survey of 105 investors in hedge funds, across a range of investor types, conducted by SEI are perhaps able to distinguish between the typical and the best in this area. In answer to the question “Do hedge funds generally do a good job of risk management?” One in five said yes, 28% disagreed and the rest were not committed.

The endowments, pension plans, family offices and consultants that completed the survey may have had in mind that hedge funds have produced losses in two out of the last four years so the recent evidence is that the typical hedge fund does not do a good job in risk management if the point of the risk framework is to produce the target return of absolute performance. However only a very small minority of capital in hedge funds is invested in “the typical hedge fund”, that is through replication or hedge fund index products. Rather there is a research process and hedge funds are actively selected.

There are around ten thousand active hedge funds today. An institutional allocation to hedge  funds might consist of as few as six funds*, but will run via, say, three funds of funds plus a few individual selections to a maximum of 100 single manager hedge funds for a large pension plan. The survey question “Do hedge funds generally do a good job of risk management?” addresses the 10,000. What if the question had been “Do the hedge fund managers you selected and allocate capital to do a good job in risk management?” Would the response have been the same?  

* see earlier article on an institutional mandate

Hedge Fund Returns Are Path Dependent - As 2011 Illustrates

One of the things that is attempted on this website is to look at market action to help explain, or comprehend hedge fund returns. For example, two years ago a commentary was distributed on the significance of the quality factor in explaining returns in 2009 (see this article), and the impact of high correlation this year was explored  (here) too. This year has been a very unusual year in the macro background and in how markets have moved - year three of a recovery does not normally look like this one in economics or markets. 

The market events of this year have been a slalom course for hedge fund managers to negotiate (risk on/risk off), and the hedge fund indices reflect that. The HFRX Global Hedge Fund Index was down 8.58% for the year up to Monday (the 5th of December), and directional funds have fared a lot worse than non-directional strategies (the former are down 18% on an index basis).

Manager letters can be a good source of market context for hedge fund returns. In particular managers taking a quantitative approach are risk aware by nature and typically have a numerically stronger way of expressing the market conditions, and the suitability of their own methodology for extracting value from them.The overview reproduced below comes from Quant Asset Management of Singapore, managers of a portfolio of global equities.

Dear Investor,

It is unusual for us to add any written text to our monthly email other than the standard text in the newsletter. Since we apply a consistent, systematic investment methodology, once familiar with the methodology, the newsletter is normally self-explanatory. But because we are currently witnessing the biggest draw-down since the inception of the QAM Global Equities fund, 71/2 years ago, we’d like to use this opportunity to share some of our thoughts on this.

We now had a period of seven consecutive negative months with the fund being down 22% for the year. The main reasons for the negative performance are:

1) We use mostly fundamental factors when selecting our stocks from a global universe of over 6000 stocks. Fundamentals haven’t been driving markets in the past seven months. Macro-economic factors were driving markets and correlations have been at an all time high.

2) We use a trend following methodology that adjust factor weightings each period for what worked well in a certain past period (dynamic) before. This didn’t work well in the past seven months due to volatility spikes and trend reversals.

3) We use a hedging methodology whereby we are either 0% or 50% net exposed mostly based on aggregate earnings revisions number and some price performance related techniques. This hasn’t added value in the past seven months.

So the question arises if our methodology is still valid and when will it work again?          

First of all; all good investment methodologies go through periods where they struggle but as long as they add value over time and make logical sense, it makes sense to stick with them in order to achieve above average returns.

Furthermore we believe that systematically picking a large number of stocks on the basis of fundamentals (valuations, earnings growth and earnings revisions) combined with a factor adaption methodology, whilst hedging out a large part of the market risk, does add lots of value. Remember that the fund is up 154% since inception. This compares to 16% for the MSCI World in the same period.

We have always allowed volatility in our funds (around 20%, which is much more than most of our peers) in order to achieve higher returns than our peers. These high returns have been achieved and we have a strong belief that they can be achieved again. In order for this to happen one has to allow certain periods of under-performance. Draw downs are pretty natural and frequent in fundamental factor adaptation systems and one should be reminded that they can create opportunities too.

Kind regards,
The QAM Team

The letter is reproduced here to give some insight to market drivers of return this year, not to point fingers at a style or a particular manager. The general point is that the vast majority of managers take a specific approach to markets that they hope works most of the time and for most market conditions. The marketing conceit of an "all weather" hedge fund or strategy died in 2008. The returns delivered by a manager are a function of their own style and the opportunity set available from the market over the period. It is very striking  that the gyrations of markets in 2010 and 2011 made it very difficult for equity hedge fund managers to make positive absolute returns except when the equity market letter was written by the Fed and other central banks through the mechanism of QE2 (from August 2010 to March 2011). 

Hedge fund returns are path dependent, not independent of the direction of markets, nor independent of changes to intra-market or inter-market correlation, nor unaffected by the extent to which markets trend. The specific sequence of ups and downs, step-wise shifts in volatility, and how long a market regime lasts impacts the ability of the manager to harvest alpha in the way they are set up to address markets. So, for example, it would not just be relevant that markets were down 5% over a six month period, but in understanding outcomes it is more relevant that they appreciated by 11% over six weeks before losing 15-16% over 4 months (with specific volatility and correlation conditions). 

It is up to the investor in hedge funds to put together portfolios of funds which take account of the various market conditions which may occur, in full knowledge of the manager style. Building such an efficient portfolio of funds can only be achieved when investors truly understand how their capital is being applied to markets by their managers. Provided the managers stick to their expressed style, there should be a limited number of surprises to investors in hedge funds given market conditions, and how market conditions change (the specific path markets follow). For any given market conditions and sequences the better investors in hedge funds will have a range of expected return per manager in which they are invested. As yet, the path dependency of hedge fund returns is not sufficiently well appreciated  - spread the word.



UCITS III Footnote - the offshore fund from QAM was down 23.49% over the period end Feb 2011 to the end of November. The onshore equivalent  - Quant Global Equities fund, a sub-fund of the Quant AM SICAV (a UCITS III type fund) - was down  27.77% over the same period. The onshore version launched in March this year.

Winton's Futures Fund is primus inter pares

David Harding

There has been a lot of comment in the hedge fund industry on the asset gathering of Winton Capital this year. David Harding's firm has attracted inflows of over $7bn in 2011, which equates to over 10% of the whole industry's capital inflows. This is a remarkable market share of the growth for an industry of over 9,000 funds for investors to choose from.

There has been some commentary that the success of such brand-name big managers is down to the dominance of American institutional flows to the industry, and the limited vision of the investment advisors to those funds. There has been less consideration of the investment performance of the winners.

The tables below come from CM Capital Markets, a Madrid based CTA. Their fund is called CapiTrade Systematic Global Futures, and since they put together and distributed this analysis their three year old managed-account-turned-fund must stack up well on CTA performance criteria. And it does.

But so does David Harding's Winton Capital over the period covered (May 2008 to October 2011). It has been well observed that Winton scaled back risk assumption on their funds during the Credit Crunch, and that since then the funds (Futures Fund and Evolution) have been run with lower risk levels (leverage). It is therefore logical in down-years for the strategy that the Winton funds have smaller losing months and more shallow draw-downs than peer funds. But the success in producing returns this year go way beyond the conservation of capital.

Winton Futures Fund has done better than the peer group in several ways this year: 7 out of 10 positive months (versus 3 for the Newedge CTA index),  a worst-monthly-loss in that time of half of the typical loss of competitors, and a positive year to date return when most CTAs have struggled to make money.

Extending the data window back to May 2008 brings BlueCrest's BlueTrend Fund into the frame as a serious competitor on the basis of performance.  Leda Braga. who runs BlueTrend, is proud to state that she has never reduced the risk appetite of the fund. This has enabled BlueTrend to produce higher absolute returns than Winton over the last 40 months, though with a higher level of volatility. If an investor is willing to take the higher volatility of return and risk assumption, then BlueTrend is a viable alternative to Winton Capital 's Futures Fund. But for the more conservative (by risk appetite) investor Winton Futures Fund is primus inter pares.

Post Script of 2nd December:

Thanks to the two managers mentioned in the above article that came forward with amendments to the data given above by CapiTrend. I should reinforce the point that the returns for 2008 in the above table were supposed to be those from May to December of that year. The returns for some leading managers for the whole of 2008 were:

AHL up 29%

BlueTrend up 43%
Millburn Diversified up 22.36%
Winton up 22%


In addition, other data quoted for Millburn in the above tables are not recognised by the Millburn Ridgefield Corporation themselves. BarclayHedge gives the annual return series for the Diversified Fund as 2008 22.36%, 2009 -7.38%, 2010 12.58% and 2011 (to Oct) as -6.75%. 

Apologies to the relevant managers from me for distributing erroneous data. I hope the thrust of the article still applies, and there is a lesson in this about the source of data and the (mis)use of it!

Macro Managers Coming Through at Last

One of the disappoinments this year has been the performance of global macro managers. At the stage of half way through the year, it seemed that if a manager in this strategy had ridden the wave of QE2 inspired up-moves in equities and commodities then they gave it back by staying too long at the party, as the effects of monetary stimulus dissipated in May and from that month onwards. Those that lost a little in the 1Q may have made a bit back by mid-year, but there seemed to be too few managers that were able to ride markets in one direction and then the other with enough conviction or timing to make money across the whole of their books.

The pattern seemed to be if you made money early in the year you gave it back later. If a manager had a positive P&L in equities, they lost enough money in FX to be left around flat for the year. To be fair to the macro managers the market action this year, whether in fx or commodities or equities, has oftentimes not been in a pronounced trend for long. So it is that CTAs, the ultimate feeders off markets exhibiting trending behaviour, did not make good money until the last few months. Further, reversals have been sharp and volatility high - which makes it hard to hold onto gains even when they have been chiselled out of recalcitrant markets. The exceptions to the generality amongst global macro traders were those that tend to specialise in fixed income - the likes of Brevan Howard - for whom the trend was their friend for long enough for decent gains to be made by end of July.  

One of things that surprised me at the half way stage in the year was that so few macro managers had made much at all. Some of these big-picture managers tend to have core fixed income books, and others express their views on Chinese growth in the fx markets or in commodities. But they all may be positioned long or short, and they decide their own timing and sizing. So there is a lot of scope for the universe of macro managers to have completely different directional bets in the same market. Those that don't do much in energy, might concentrate on time spreads in softs or run a big book in credit trading. The point is they need not have correlated returns at all - in fact logically the universe of global macro managers should always have the biggest dispersion of returns amongst hedge fund strategy groups, and most of the time it does. By happenstance, taking all these different views and putting on unrelated trades across a wide selection of markets, hardly any macro managers had made good returns by the end of June this year. However the market gyrations of August and September have allowed a different story to be told for the period since.

Only this week Luke Ellis of Man Group was commenting that there was a very wide dispersion of manager returns amongst hedge funds in August. In September there was an historic extreme of dispersion of returns amongst managers running hedge funds. So for observers of, or investors in, hedge funds the returns of August and September become much more about which managers you were in, rather than which strategies you were allocated to. And practically it means that index or industry level returns for hedge funds for those two months start to be quite unrepresentative. We are well used to seeing headlines about "Hedge funds failing to deliver this month/on the year to date" based on index level returns, and sometimes (more usefully in this context) about returns across a hedge fund database being "good" or "bad" or generally different from returns on the underlying markets at an asset class level.

When the YTD numbers are close to zero, the next data point has a big impact on YTD returns. That is what has happened to hedge fund returns this year, and for some global macro funds in particular. The tables shown here are from "Absolute Return" magazine  and pick out amongst US-based managers the best returns produced last month. It is pleasing to see the marked presence of macro managers at the top of the rankings after the year they have had.  

These are good returns of specific managers in the global macro investment strategy. However, today I see that The Greenwich Investable Hedge Fund Indices give the index level returns for macro managers as -0.79% for September and -3.72% for the year so far. My experience of dealing with investors in hedge funds is that they are looking at what their specific hedge fund managers have done for them. There will be nearly no one who has experienced a return from their macro managers of -3.72% in the year to date (for reasons of position sizing and the timing of subscriptions and redemptions, if nothing else). Given the extreme dispersion of returns in September, and that macro managers have the widest dispersion of returns amongst any hedge fund investment strategy I can confidently say that no-one except an index investor has actually got a return of -0.79% from their macro managers last month. The inference is that the returns of the last two months will tell investors a lot about the quality of manager selection amongst their advisors and consultants, and amongst funds of funds. And not just in global macro.

Additional:

(Dec 7th 2011) Reuters posted an article headed "Global macro hedge fund returns fail to impress". The full article is posted here. The article mentions Louis Bacon's Moore Global Investments, Fortress Investment Group, Tudor Investment Corporation, Caxton Associates and Brevan Howard.

Truly Knowing the Family Office Client is Hedge Fund Marketers' Most Important Challenge Now

Family offices are viewed as having a series of advantages as investors in hedge funds:

1. Family offices tend to have long-term investment horizons.
   
2. They tend to want to live with decisions for some time – as a source of "sticky money" they won't flip a multi-year investment proposition after a couple of bad quarters.
   
3. The investment decision making is often quicker than either funds of hedge funds or institutional investors that use consultants to select hedge funds.
   
4. Due diligence of family offices is less invasive and time consuming than for investing institutions.
   
5. They typically require less client servicing resource than other investors in hedge funds.
   
6. They tend to have less restricted selection criteria than institution al investors – family offices can invest in niche strategies, emerging managers and small funds.

 
Rothstein Kass, the US based professional services firm, last month produced some timely research from talking to 67 family offices in the United States and 84 from outside the U.S. The research indicates that roughly 85% of single-family offices currently invest in hedge funds, and nearly half invest in private equity vehicles. Of those family offices that have existing hedge fund investments (and only they were invited to participate in the survey) nearly 90% of them (88.7%) considered themselves highly likely to add to their investments in hedge funds. Whilst there was no timeframe qualification posed in the question, this means that family offices are probably the most likely group to increase hedge fund commitments of all hedge fund investor types (HNWIs, endowments, pension schemes, insurance companies and charities).


The willingness to commit further capital to hedge funds would put family offices as the investor type with the highest proportional commitment to hedge funds of all. Each year The Institute for Private Investors surveys its 1100 ultra high net worth members to ascertain performance obtained and attitudes to and exposure to the various investment strategies and asset classes. The Family Performance Survey of 2010 (published by Campden Media) gives the average asset allocation across all family offices in this predominantly (89%) American population. As at the end of December 2010 the average exposure to hedge funds and funds of funds of the respondents was 19% of the total assets. This level was similar to that reflected in the 2009 survey, but remains at the top of the range of exposure compared to pension plans, insurers and some endowments. So family offices are already well committed to hedge funds, and have more exposure than others, even before they make further commitments.

 
Over the years studying family offices, Rothstein Kass has developed a number of different segmentation criteria. One very powerful segmentation model is based on psychographics and distinguishes between family offices that are Wealth Creators and those that are Wealth Preservers. Wealth Creators are charged with enhancing or increasing the fortunes of the underlying family. In contrast, Wealth Preservers are focused on ensuring the safeguarding of the underlying family's wealth. In this study the greater majority of the single-family offices can be classified as Wealth Creators, as shown in Graphic 1. The identification of the correct segment for the family office should be very significant for those marketing hedge funds as it feeds into general risk appetite for hedge funds and into the appetite for specific hedge fund investment strategies (Table 1).


Graphic 1. Wealth Creators (70.9%) versus Wealth Preservers (29.1%) amongst Family Offices
 

Source: Rothstein Kass, where N=151 Single-Family Offices


This is how Cheryl B. Rogers, Senior Vice President at Forbes Private Capital Partners (which was involved in the research), has experienced these characterisations in practice: "Many single-family offices pursue investment diversification strategies that blend aspects of both wealth creation and wealth preservation. However, most are clearly weighted toward one overarching philosophy that is often dictated by individual family circumstances. At this stage the alternative investment is sufficiently diverse to offer suitable investment options for investors of nearly all risk tolerances. Wealthy clients nearing retirement, for example, are more likely to pursue a wealth preservation strategy to guard against fluctuations that would negatively impact their lifestyle or restrict the generational transfer of wealth. They tend to gravitate toward alternative products that offer annuity-like returns or hedge more aggressive positions."


The survey evidence (shown in graphic 2) is that the family offices with a wealth creation investment ethos are more likely to add to their hedge fund investments than the wealth preservers. Part of the motivation for this was expressed by Bruce H. Rogers, Chief Brand Officer and Managing Director at Forbes Insights, one of the research organisers. He said "many high net-worth families are seeking to recoup wealth eroded during recent periods of market weakness. These "wealth creation" investors tend to be relatively less risk averse than those pursuing wealth preservation strategies."


Graphic 2. Most of Respondents Highly Likely to Add to Hedge Fund Investments are Wealth Creators (77.6%)

Source: Rothstein Kass, where N=134 Single-Family Offices, Wealth Preservers 22.4%

When it comes to investment strategies engaged in by hedge funds, the preferences of family office investment directors are like those of hedge fund investors generally in some ways, but not in others. Table 1 shows the expressed preferences by strategy of the family offices which were highly likely to add to their hedge fund investments. Like the respondents to the Deutsche Bank Alternative Investment Survey of March this year it is most common (53% of respondents) to state a preference of allocating new money to long/short equity funds, and it is similarly common (48%) for family offices to express a preference for distressed funds. The bias of family offices towards distressed funds was not shared by the broader range of participants to the DB survey, which had distressed funds in the lower half of the preferences ranking. Emerging markets, global macro and event driven funds are all a lot less popular as recipients of fresh investment capital amongst family offices than amongst the broader range of hedge fund investors.


Table1.

Source: Rothstein Kass


I noted at the start of this article that family offices have a series of perceived advantages as investors in hedge funds. Then I observed that family offices are probably the sort of investor most likely to be adding to their hedge fund investments in the medium term. Putting these concepts together will have some consequences for those who seek family offices as potential clients: the Rothstein Kass research notes that the competition for the investment dollars of family offices will probably grow geometrically. To succeed in this market hedge funds may have to raise their game in the marketing/sales process.


Rothstein Kass have a view on this – "investment managers will need to be highly consultative if they are to succeed in generating capital flows from single-family offices." They describe the consultative approach as having three basic components. Central to this approach is profiling the single-family offices to understand: (1) their investment orientation, (2) the roles, responsibilities and professional objectives of the Executive Directors, and (3) the professional ecosystem of each single-family office. The other basic components of the consultative approach are "creating customized explanations of offerings" and "continuously managing the relationship."


Here is the meat. The authors of the research say that "when it comes to the consultative process, we regularly find the greatest weakness among (provider) financial firms is in their profiling of family offices." They continue that "investment managers are well served by maintaining an open and ongoing dialogue with family office investors to ensure ongoing alignment of objectives and risk tolerances."


While it may be a regulatory requirement to "know your customer", there is a genuine commercial angle here. Successful selling to family offices is much more likely to occur where the selling hedge fund has made the effort to know how the family office actually works, and what the risk tolerances are (wealth creator or wealth preserver), and puts resource into developing a relationship with the key decision makers that goes beyond the immediate need to sell some product. This may be the hedge fund marketers (internal or third party) most important task in the immediate environment.

Out of the Box - Graphic of the Day – Why Hedge Funds Will Continue to Grow

One of the advantages of looking at the activities of institutional investors is that their behaviour follows decision-making which stands for years at a time. The Investment Committee of a pension plan changes the strategic asset allocation say every 5 or more years. There may be a decision made to have 25% of plan assets in domestic equities with a tactical band of 20-30%, which allows for variation on an annual basis away from the central tendency of 25%. But for most of the time over six or seven years the plan assets will be around 25% in domestic equities from that point onwards, after a period of implementation.

The implementation of the change in asset mix will often take place over a year or more as mandates are changed, contractual notice is given to the money managers with the mandates, and the underlying assets are bought and sold. Allocations to domestic equity have tended to shrink over recent years, so the process might involve a plan sponsor giving six month notice to a Trust Bank that their mandate will halve in size, and then, in six months time the bank will liquidate a portion of their large cap mutual fund and transfer the cash to the pension plan's administrators.

The reverse process is expected to happen for hedge fund allocations over the next few years if the survey of investment consultants by Casey Quirk and eVestment Alliance is to be believed. The survey*, conducted in Dec 2010 and January 2011, asked investment consultants to forecast investment preferences and buying behaviour among North American institutional investors during 2011. One of the key trends that Casey Quirk identified was "The increasing role of heretofore "alternative" investments—hedge funds, private equity and real estate—which are emerging as the centerpiece of active asset management moving forward."

This trend in the use of alternatives reflect the new frameworks with which institutional investors and their consultants are building portfolios, with exposure defined less by product packaging or home bias, and more by the specific contributions investments make toward overall objectives. The framework is part of the new emerging paradigm for asset allocation amongst investing institutions in North America, shown in the Graphic of the Day below, and which will reinforce hedge fund growth.



Graphic of the Day  - Hedge Funds Break out of The Box
The Emerging Institutional Investment Framework

Source: Casey Quirk (Note Not to Scale)

The key point in this is that the way institutional investors see how they can use hedge funds is changing. It was hedge funds as part of an alternatives category - in a segmented ghetto by risk/return. This is changing towards hedge funds as sources of alpha within broader asset categories.  Hedge funds are breaking out of the box!

Putting this framework, and the consequent asset shifts, into practise over coming years will not benefit all asset management businesses. Amongst the attributes of the winning asset management firms, according to Casey Quirk and eVestment Alliance, will be

• Managers offering non-correlated investments.
  
• Firms offering both "traditional" and "alternative" investments will stand the best chance of providing institutional clients with a total portfolio solution.
  
• Product development and innovation will remain critical competitive differentiators.
  

The survey collators go on to turn their gathered insights into a product opportunity map – showing where demand for product will be strongest.



2011 Product Opportunity Map

Source: Casey Quirk, eVestment Alliance

It is important to understand that the product opportunity map compares expected search activity for the upcoming year relative to forecast from the previous year. What is clear is that consultants continue to believe that longer-term trends in search activity favour hedge funds, funds of hedge funds, and non-U.S. equities. However, there is a perceived shift in the demand for funds of hedge funds:

"Consultants focused on larger investors, as well as those focused on non-profit funds, expect more searches for direct investments in hedge funds than they did in 2010. This reflects three realities.

• First, most North American institutional investors selected a core fund of hedge funds in recent years, and few are yet convinced they need a change.
  
• Second, and more importantly, larger investors now seek more specialized FOHF strategies in place of, or in addition to, a diversified FOHF mandate. This challenges many FOHF vendors who do not offer a focused product.
  
• Finally, larger institutional investors—particularly well-funded non-profit funds—still seek to avoid higher fees and pooled vehicles offered by FOHFs.
  

FOHFs remain core investment vehicles among smaller pension plans who lack resources to select or access direct hedge fund investments. Additionally, investors increasingly are using outsourcing firms to provide exposure to a portfolio of hedge funds."

 
The trends identified by the survey authors will likely persist for some years, as allocations in pension plans change slowly, and allocations to hedge funds are going up – doubling in some forecasts. So hedge fund capital flows should be positive at the industry level on a multi-year outlook. There is still a role for funds of hedge funds serving American institutions, and indeed there should be growth in assets this year and next for funds of hedge funds as a whole. But to benefit from those allocations funds of hedge fund businesses are going to have to be in the top quintile of performance ranking over 5 years, and in 2008 specifically, or have a very good specialised product (by geography or investment strategy) to offer.





*This year, 55 investment consultants, representing an aggregate $10.4 trillion of assets under advisement participated in the survey.

A State Pension Plan Hedge Fund Mandate - It Takes a While

American investing institutions are the dominant source of capital for the hedge fund industry. It is important to understand how and why they act. The Wyoming Retirement System just announced who would be managing its assets for its first hedge fund allocations. The winners of the mandates are not surprising, but here the focus is on the process that resulted in those winners. A search of the internet for references to the Wyoming Retirement System and hedge funds allows you to put together a chronology from the headlines:

June 2001: "Wyoming Studies Alts"

…The Wyoming pension fund is planning to make a decision about whether to push into alternatives investments such as real estate, private equity and hedge funds. ..Plan officials are working with the fund's consultant Buck Consultants.

August 2004: "Wyoming Puts Hedge Funds on the Back Burner"

…Wyoming has been slowly continuing its hedge fund education ... and would likely consider a fund of funds to temper its risk…

November 2004: "Wyoming to Decide on Hedge Funds Next Year"

…The plan has been mulling an allocation to hedge funds for more than a year…Mellon Consultants is advising…

March 2005: "Wyoming Appoints PIMCO for Absolute Return Mandate"

March 2009: "Trent May Joins Wyoming as First CIO"

…Trent May joins from hedge fund Deer Creek Capital Partners…

August 2009: "Wyoming Taps NEPC as General Consultant"

November 2009: "Wyoming Considers Its First Hedge Fund Investment"

… The change of tack has much to do with the retention of New England Pension Consulting as an advisor by the retirement system in September…

April 2010: "Wyoming Board Gives Permission to Invest in Hedge Funds"

August 2010: "Wyoming Puts out Combined Search"

…Wyoming Retirement System, is searching for multiple managers to run up to $560 million combined in a global tactical asset allocation strategy and a global macro hedge fund strategy… The system plans to hire three to six managers for a global macro hedge fund mandate, which will make up 30% of the $560 million. Trent May said the number of managers hired for both investments is dependent on RFP responses. The two investments will make up about 10% of the entire portfolio.

~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~

As a responsible and accountable public body the Wyoming Retirement System has to make available documentation for its processes and meetings. The source document for the combined search is well put together, and can been seen here.


The selection process uses the Due Diligence Questionnaire (DDQ) as the key screening document. The risk/ return data should reduce the list of all applicants down to long list. And the DDQ can be used to get to a short list that can be evaluated for full-blown due diligence. New England Pension Consultants have put together some great questions to ask in addition to those in the standard questionnaire. They are in the full document for which the link has been given. In this case NEPC have used the Greenwich Roundtable Global Macro DDQ as the starting point – and very good that is too, as are all the Roundtable Guides. The following are extracts from the request for proposals for the hedge fund mandate:

Global Macro Hedge Fund Managers

To be considered for appointment as a global macro hedge fund manager pursuant to this proposal, investment management firms shall have not less than:

1. $250 million of verifiable total firm assets under management
2. Two (2) years verifiable Global Macro investment experience

 

List of Requested Documents & Data

DDQ

Pitchbook

Historical Monthly Returns & Monthly AuM in Excel

Organizational Chart

PPM

Biographies of Principles and Investment Professionals

Latest Monthly/Quarterly/Annual Letter & Risk Reports

EVALUATION AND SELECTION

Proposals will be evaluated and subsequent judgments made taking into account the following criteria:

• Performance – Return and volatility expectations. While each manager will be evaluated on its relative investment merits the aggregate GTAA allocation will be measured against a 60% MSCI ACWI / 40% Barclays U.S. Aggregate benchmark.

• Expertise – (a) Similar work performed for other institutions, with references of such funds to be specified in the proposal; (b) Assets under management; and (c) Investment experience broadly defined and experience in global tactical investments specifically.
  
  
• Key Personnel – Personnel to be assigned to this account, including key professionals, applicable portfolio managers, back-up and other staff assistance, and education and experience of all such key personnel.
  
  
• Fees – Reasonableness and competitiveness of fees.

• RFP Proposal – Clarity and responsiveness to requirements as requested in the RFP.

• Philosophy and Style - the extent to which the proposed philosophy and style best complement existing philosophies and styles and meet the requirements and expectations as presented in this RFP.
  
  
  Selection Process:
  
• All RFP's will be reviewed with respect to the evaluation of the proposal by the Wyoming Retirement System's staff and the Board's investment consulting firm, New England Pension Consultants (NEPC). WRS' Chief Investment Officer, with the approval of the Executive Director, and in consultation with NEPC will be the sole judge with respect to the final selection of the firm(s) hired.
  
  
• Finalists will be notified of the results of the RFP selection process as soon as possible following selection; due diligence visits may be arranged with firms who make the finalist list.
  
  

The result of the search is that Moore Capital Management, Graham Capital Management, Brevan Howard, Caxton Associates and BlueCrest Capital Management have each been given $30m of capital, and a further global macro manager is expected to be appointed. Although the RFP gives threshold criteria of at least $250m in AUM and a minimum of a 2 year track record, which give scope for dozens of firms to qualify, it is hard to argue against the selections made. Amongst the five named there is a good variety of style, bias by asset class, and differences in pattern of return. It has taken a while in this particular case, but it is easy to see, given the process, why the hedge fund industry continues to get more concentrated as it is driven by American institutional investor flows.

Past the Low Point for Funds of Hedge Funds

It has been a tough time for funds of hedge funds post the Credit Crunch. At last it looks like the aggregate assets under management are beginning to emerge from the prolonged bottoming phase. Three months ago there was a comment here on the flat-lining in asset flows for North American funds of hedge funds. But the latest survey evidence from Preqin shows a rather more constructive outlook. 

Whilst the aggregate is little changed:

Graphic One: Aggregate Fund of Hedge Funds Assets under Management

 

Source: Preqin

The detail shows that more of the fund of funds sector is experiencing positive changes in AUM:


 

Graphic Two: Changes in Fund of Hedge Funds' Assets under Management since 2007

Source: Preqin

• The proportion of funds of funds experiencing a fall in assets has gone from a substantial minority last year (42%) to only a small minority (17%) this year.
  
• Much more of the industry has experienced stability in AUM this year – 55% of FoFs have seen no change in assets so far this year compared to last year.
  
• The proportion of funds of hedge funds having an increase in assets is up to 28% in the 1Q of 2011.
  

If these trends continue the total AUM for funds of funds could rise towards $950bn by year end, in Peqin's estimation. This would be a good fit with evidence suggesting that institutional investors will be increasing their allocations to hedge funds. According to the recent Deutsche Bank survey on hedge funds, in aggregate institutional investors do expect to increase their allocations to hedge funds in 2011. The majority of investing institutions (77%) expect to keep their allocations as they were, but more (21%) expect to increase allocations in 2011 than decrease them (2%).

 

The outlook for funds of hedge funds is the most positive we have seen for at least 3 years. Preqin's version is

 

"The fund of funds landscape is markedly different to the pre-crisis industry. Assets under management for the industry as a whole are much lower and there is a bimodal distribution of firms emerging, with peaks at the lower end of the scale as the smaller niche boutiques appeal to the maturing hedge fund investors, and at the larger end of the spectrum the "brand name" multi-strategy firms still prove appealing to the newer investor. After a difficult few years for funds of hedge funds, the managers that have appropriately adapted to retain investors from the institutional market have regained some lost confidence and numerous new funds are poised to be launched this year. Growth of industry assets is again in positive territory and if this new era of revived investor interest in funds of funds continues then aggregate AUM will begin to climb towards the $1 trillion mark."

The fund of funds part of the hedge fund industry is not going to return to growth in the way it experienced it before – not all funds of funds will benefit in this more mature phase of the industry. But in aggregate the low point for the sector has been passed.