| Henry Davis |
Henry Davis, president of Arden Asset Management in New York, is leading the $11.8 billion alternative-asset management firm into uncharted waters. Arden started in 1993 as a fund-of-hedge-funds firm, but it is adapting to a changing world as investors grow more sophisticated and go directly to hedge funds. It has been among the first fund-of-funds firms to take on a consulting role. Arden used to invest in hedge funds for the Massachusetts Pension Reserves Investment Management Board, but in 2012 MassPRIM’s board of directors elected to invest directly in hedge funds. This summer the two parties agreed to a deal in which MassPRIM will retain Arden as a hedge fund consultant. Two years ago Arden launched its first liquid alternatives fund, and now manages some $1.26 billion in multimanager liquid alternatives. Arden spoke with Alpha about moving on from the old fund-of-funds model. Q: What made you decide to take on the role of consultant?
A: Everything starts with the client. We’ve tried to be good listeners to our clients. Also, we’ve tried to position ourselves to have a real value proposition for them. So we started asking ourselves, What is it that we have that these institutional investors don’t have? And what do they need help and support in doing? That took us to a couple of interesting areas. For the most part, institutions don’t have voluminous amounts of investment manager research, which is something we’ve been compiling since we started 21 years ago. We’re a research shop, and we have over 50,000 reports that we’ve written on hedge fund managers.
Q: You have marketable resources as a fund of funds, then.
A: Yes. I can type in the name of a manager, and I can tell you about the first meeting we had with that manager. Say the first meeting we had was 11 years ago. I can read you the report on what we wrote about them then and compare it to what we wrote about the manager a year ago.
Another skill we have is portfolio construction. Most institutional investors build their hedge fund programs from the bottom up, but we can apply top-down portfolio construction technology, where we can help a client optimize a portfolio and figure out the strategies they want to be overweight and where they want to be underweight, as opposed to just identifying who the best managers are and investing with them. We can also provide risk monitoring and oversight, which large pension plans typically don’t have in-house. And we can provide operational and infrastructure due diligence. We’ve used all of these capabilities for ourselves, but we took a step back and saw that those capabilities could be used more broadly. Why not support a long-standing client who might be managing a direct program?
Q: Couldn’t you provide the same services through a customized account?
A: It goes back to what the client wants. We have clients who are set up in managed accounts. We have 18 funds of one, in which we are the sole investor in a specific vehicle. Ultimately, the clients know what they want. Maybe once in a while, a client will ask what we recommend. We probably would say a fund of one, in that case, just because more than 50 percent of our assets are in that type of structure.
Q: As a consultant, don’t you miss out on the benefits when a hedge fund performs well?
A: The economics are different in consulting. But it’s pretty unusual today, even in the fund-of-one structure, for there to be participation on the performance side. Some funds of funds are skewing more to a management fee side, and some are going the other way. However, with the consulting arrangement you don’t have any sort of participation in someone’s 40 percent return.
Q: How do you work out the compensation structure as a consultant?
A: This is a new area for us. I think each deal is going to be case-by-case. The client and the provider will agree on commercially reasonable terms. I think it probably really depends on the scope of services.
Q: What other changes do you foresee in the fund-of-funds business?
A: We’ve stopped even calling ourselves a fund-of-funds provider. We view ourselves as an alternative-asset management firm. We are a hedge fund specialist.
Q. Would you ever consider running your own single-manager funds?
A: This is an interesting topic because when you start running managed accounts you realize these are your accounts. You’ve just subcontracted and authorized someone else to trade on your behalf. So at some point, if you follow the continuum, there are things you don’t need to subcontract a fund manager to do — let’s say there’s a hedging component that you can implement less expensively through a passive instrument. But in answer to your question, we don’t have any intention of starting a single-manager fund. Other groups have done it, and that’s logical. But we’re seeking to partner with our managers, not compete with them.
Q: Are your liquid alternative funds aimed at the retail market, or are they of interest to institutions as well?
A: The lion’s share of our investors are institutions, and they are starting to ask about the 40 Act funds. They’re asking us questions like, “Could we use this as a cash substitute for our private equity program, as a way of keeping invested while we’re awaiting a capital call?” We think that’s a pretty neat idea. The idea of institutions investing in liquid alternatives in general is pretty compelling if you think about what you can get in these structures. You get all of the benefits of managed accounts — the ability to customize your investment mandate, control of the assets, the ability to negotiate fees, 100 percent transparency — along with daily liquidity. The one area of limitation that is significant is the absence of illiquidity. If you’re investing in hedge funds to get access to something that’s illiquid, liquid alts aren’t for you. But for investors who want their illiquid holdings to be in their private equity bucket, the idea of giving up illiquidity in their hedging strategy isn’t such a loss.
