That giant sucking sound of investors yanking money from hedge funds isn’t half as loud in the parallel universe of funds of hedge funds. Institutional investors, which typically prefer to access hedge funds through multimanager vehicles, have risen to the occasion, manning the fund-of-funds barricades in an industry that at the end of June approached a record $900 billion in assets under management.
“We read in the industry press lots of general, blanket statements that funds of funds are facing redemption pressure, but we are not seeing a significant level of redemptions,” says James McKee, a senior vice president and director of hedge fund research at San Francisco–based investment consulting firm Callan Associates.
Though a not-insignificant number of wealthy households and estates have pulled money from funds of funds, most pensions and foundations appear to be standing behind this year’s Alpha Fund of Funds 50, our seventh annual ranking of the world’s biggest multimanager hedge fund firms. The list features many of the usual suspects; some of the biggest and best known say the radical drawdown of hedge fund assets this year has largely been avoided by most funds of funds.
[Click HERE to view the complete rankings of the 2008 Fund of Funds 50.]
“We budgeted at the beginning of the year for 10 percent in redemptions of fee-paying money,” says J. Tomilson Hill, president and CEO of New York–based Blackstone Alternative Asset Management. “We have come in well under that.” Blackstone, No. 8 in this year’s ranking, with $31.5 billion in assets under management at the beginning of July, had $30 billion at the end of September.
Executives at No. 1–ranked, Geneva-based Union Bancaire Privée, which had almost $57 billion in assets under management at the end of June, say institutional investors have been particularly faithful in recent weeks. Roman Igolnikov, the New York–based chief investment officer at UBP Asset Management, concedes that the industry is “obviously challenged” but says inflows have outpaced redemptions.
“We’ve had inflows,” says Jane Buchan, CEO of Irvine, California–based Pacific Alternative Asset Management Co., which is ranked No. 17, with $18.9 billion in assets as of the end of June. Institutional investors have decided “they can’t just take it off the table and put it under the mattress,” she adds.
Jim Vos, CEO of New York–based Aksia — a firm that advises institutional investors on funds of funds and whose clients include the Indiana Public Employees’ Retirement Fund, the New York State Common Retirement Fund and the Ohio School Employment Retirement System — said in an October 21 letter to clients that funds of funds “with more of their assets from ‘distributed products’ are facing 20 percent to 35 percent redemptions.” By contrast, Vos predicted that those that rely on institutional investors could see a 10 to 15 percent drawdown.
The fund-of-funds industry was launched in Europe 40 years ago, then established independently in Chicago in 1971 (see “Sweet Home, Chicago,” page 48) as a way for wealthy individuals to get a diversified piece of the burgeoning hedge fund market. The industry has long since gone global, and the explosive growth of funds of funds, especially in the past decade, has mirrored the boom in underlying assets — namely, the hedge funds themselves.
Although funds of funds are perennially criticized for the layer of fees they add, supporters say their value — in day-to-day management, due diligence and trend-spotting — is now more apparent than ever. Chief among the benefits a fund of funds is said to bring is the avoidance of what institutional investment managers call headline risk: the ever-present danger of putting money into a hedge fund that blows up, through fraud, bad luck, incompetence or some spectacular combination of all three.
“Most large institutions do not feel they have the competence to make the right choices and create portfolios and do ongoing risk management and monitoring,” says Blackstone’s Hill. That’s where a fund of funds earns its keep and where Hill says investors — once they have made the leap to alternative investments — have to keep in mind what they’re getting.
It seems most fund-of-funds players — investors and managers alike — are holding their breath, waiting to see whether the middle holds. However, recent events have muddied any assessment of current and future data, as markets have crashed and some investors have bolted — or taken out options to bolt. Since August a large number of investors have reportedly filed formal notices to redeem, guaranteeing them the right to pull their money after 30, 60 or 90 days, depending on the fund in question. Part of whatever is happening may be a kind of bluffing. “It’s hard to get hold of numbers,” says Phil Irvine, co-founder and CEO of PiRho Investment Consulting, a London-based firm that specializes in advising institutional investors on funds of funds. “But if everyone thinks there’s a redemption run, it forces some of these hedge funds to actually gate,” a move that curbs withdrawals. “There’s maybe a game being played here,” Irvine adds.
Still, the size of the fund-of-funds industry is probably not what it was a few months ago. As of June 30 assets under management totaled $877 billion for the Fund of Funds 50, up from $742 billion in 2007, which was up drastically from $550 billion in 2006.
Some pockets may suffer more than others, however. Those familiar with big Europe-based funds of funds note that they tap two markets, one less reliable than the other. Firms like UBP can typically count on the almost exclusively institutional investor market in the U.S., which is in it for the long haul. Not always as loyal are retail investors, individuals with less staying power than the typical university endowment or foundation.
Few dispute that some basic reshaping is under way.
“The truth is, we don’t know how investors are going to react in a given situation,” says Richard Leibovitch, a Boston-based senior investment partner at Lausanne, Switzerland–based Gottex Fund Management, No. 20. Gottex, one of the few funds of funds that publicly reports quarterly numbers, had $13.5 billion in assets under management at the end of September, a 13.5 percent decline from June 30, and in mid-November gated some funds. Leibovitch says this has not swayed him from his long-term confidence in the industry: “It’s shifted from leveraged high-net-worth individuals to conservative institutional investors, whose patience is greater.”
What’s worrisome is that Leibovitch and others see a hedge fund shakeout coming. “The impacts are just beginning to be felt,” says Sophia Brickell, an investment specialist at London-based GAM, which ranks No. 12, with almost $25 billion in assets under management. Brickell cites data that suggest 700 hedge funds could close this year: “Anecdotally, we hear it could be closer to 1,000.”
Brickell notes that broad hedge fund success in the past few years, whipped on by easy credit and rising markets, helped the weak prosper with the strong. The inevitable Darwinian correction is occurring.
“We will see a flight of capital toward those that are actually doing the hedging,” says Niket Patankar, CEO of Adventity, a New York–based consulting firm whose clientele includes about 50 hedge funds and ten funds of funds.
