Investors eye more direct hedge fund path-consultant

Date: Wednesday, November 15, 2006
Author: Tom Burroughes, Reuters.co.uk

GENEVA (Reuters) - Funds of hedge funds are likely to change how they operate and offer more tailor-made advice as institutional clients become more confident about investing directly in the $1.7 trillion (900 billion pounds) hedge fund industry, a consultant said on Wednesday.

Clients like pension plans, who are pouring billions of dollars into alternative assets like hedge funds, will increasingly demand that fund-of-hedge-fund companies give more bespoke advice and consultancy service to justify their fees, Kevin Quirk, partner at Casey, Quirk & Associates, told a conference.

"Business models are going to change in the fund-of-funds industry," he said at the Global Alternative Investment Management conference.

Funds of hedge funds currently take the lion's share of institutional money because these companies spread money among a variety of different investment strategies, cutting the risk that a client will lose a big chunk of money if a hedge fund fails.

Funds of hedge funds normally charge an additional layer of fees on top of the sums levied by the individual portfolios. A hedge fund typically charges an annual management fee of 1 to 2 percent of assets and performance fees of up to 20 percent. To justify the added fees, fund-of-fund firms say they take care of monitoring investments on a client's behalf.

Institutions have been attracted to hedge funds because of the losses that pension plans suffered in the equity bear market after 2000. Hedge funds can make money in different market conditions by using techniques like short-selling - profiting when a price falls. These vehicles also appealed to pension schemes struggling to pay for a greying population.

When a pension plan takes on a hedge fund exposure for the first time, the vast majority of such retirement plans use the fund-of-hedge-fund route, but over time more schemes are likely to opt to invest directly or use a fund-of-funds company in an advisory role, according to a report by Quirk's firm and Bank of New York in October.

The report predicts that by 2010, institutions will put half of the assets directly into a hedge fund and the other half through a fund-of-fund platform.

Some industry executives say the case for diversifying risk was greatly boosted when U.S. hedge fund Amaranth suffered massive losses earlier this year through wrong-way bets in the energy market.

RAPID GROWTH

The Bank of New York and Casey, Quirk & Associates report predicted that institutional investors like pension plans and insurance firms will hold more than $1 trillion of assets in hedge funds by 2010, up from $360 billion now.

Such investors will account for more than half of the total money coming into hedge funds through to 2010 and pension schemes alone will make up about 65 percent of all institutional flows to the sector.

Hedge funds started out as an obscure part of the investment world, primarily serving wealthy individual clients but have become a more recognisable part of the financial industry in recent years, drawing increasing scrutiny and commentary from national regulators.

Pensions, insurers, endowments and other big institutions are likely to spend resources on developing in-house expertise in looking at hedge funds investments and devote less time in using external managers, said Markus Ohlig, principal at Greenwich Associates, a U.S.-based research firm focusing the financial industry.

Greenwich, in a report issued in November, found that some investors were unhappy about the performance and standard of service from some hedge fund companies. "Some of the lack of satisfaction with managers is really quite astounding," Ohlig told the GAIM conference.

Continental European pension funds typically manage 70 percent of their assets in-house. By contrast, overall, British schemes outsource 100 percent of their assets to fund management firms, he said.