Performance is an issue, but price is the bigger problem

Date: Thursday, November 1, 2012
Author: Nick Evans, Hedge Fund Intelligence

It is not at all clear that hedge fund managers see how much the end-investor world has changed

Attending the InvestHedge Forum this month was in some senses a tonic for anyone who has been a bit dispirited by the generally – although by no means universally – rather pedestrian hedge fund performance of late.

Seen from the perspective of investors, hedge funds are basically doing OK. That was the message from InvestHedge’s well-attended annual get-together, which drew a capacity crowd of 500 people from all sides of the hedge fund investor spectrum.

They could be doing better, for sure. But they could just as easily be doing worse – in what remains a very difficult and potentially very dangerous investing environment.

And, for the most part, they are doing what most investors want them to do – which is to reduce volatility and/or risk and to protect on the downside, while also providing portfolio diversification and participation in rallies such as that seen over the past few months.

There was little sign of panic, or even particularly of disappointment, among most investors – certainly on the institutional side. And the general tone of the event was, by and large, both reassuring and reasonably encouraging.

But it was also a little unsettling. For it made plain a very profound difference in the ways that the newly-dominant institutional investor base looks at hedge fund investing, and in the things that these newer types of investors want and expect from hedge fund managers.

And it is not at all clear that hedge fund managers themselves see fully the extent to which the world has changed – in terms of how these types of investors look at things generally; how they look at hedge fund performance (both individually and collectively); and how they go about assessing whether hedge funds are performing the role that they need them to perform in terms of their overall investment portfolio strategies and objectives.

It is profoundly wrong to view hedge funds as some kind of homogeneous mass. But, by the same token, it is equally misguided to see investors (and, most of all, institutional investors) as all being somehow cut from the same cloth too.

If anything, the investors are even more diverse than the managers – in terms of what they are trying to achieve; in the role that they perceive for hedge funds in their broader portfolios; in the types of managers and funds and strategies that either appeal or do not appeal to them; and in the types of results that will ultimately convince them that they were either right or wrong to allocate assets to hedge funds in the first place.

For most investors hedge funds are just one tool in a fairly well-stocked kit-bag. That is true for the hedge fund industry as a whole. And it is all the more true at the level of the individual hedge fund manager or the individual fund allocation.

Whether they choose to invest via consultants, or via funds of funds, via managed accounts or via direct allocations to underlying hedge funds is not really the issue – although clearly there is a battle royal brewing between investment consultants and fund of fund intermediaries to gain market share in the fashionable new ‘investor advisory’ space, with some potentially ugly conflicts of interest looming on the horizon.

The main issue –for most investors – is a rather simpler one. Are my hedge fund investments doing what I, individually, want them to do? Am I investing with the right kinds of funds – for me? And am I paying the right price for what I want and expect them to do?

On current showing, the evidence is mixed – at best – on both a short-term and a relatively longer-term horizon. But, just as many managers concede that they are unlikely to produce in the current economic environment the kinds of returns that they were able to produce in the past, it is surely not unreasonable to expect many investors to say that they are now reluctant to pay the kinds of fees that they might have been prepared to pay in the past.

As far as funds of funds go, that battle has already been lost. The double-layering of fees at 1/10 on top of 2/20 is a thing of the past. Too many funds of funds simply proved unable to deliver the necessary added value.

Quite what the new price for hedge fund intermediation should now be – whether in terms of consultancy or advisory work, in terms of direct hedge fund placement, or in terms of either customised or commingled multi-manager portfolios – is now a pressing question.

But it will not end just at the intermediary level. It is a debate that is moving centre stage with hedge funds too – with Caxton becoming the latest major firm to cut its fees.

So performance may be an issue. But it is not the principal one – and the evidence so far is that investors are showing more patience on that front than many managers might have been entitled to expect. The big issue is price. On that score, investors are not so happy.