If there is one thing investors have learned since the crisis, it is that doing due diligence on hedge funds – whether it is manager selection or operational due diligence on asset allocation – is a highly valued skill, believes Nick Phillips, head of third party distribution, Europe Middle East and Africa at Goldman Sachs Asset Management.
The institutions that have recently been approaching sub-advisers for these skills, many of them for the first time, have mostly been private banks. And it is the alternatives area which they are particularly interested in. Typically, they would not have in-house expertise, explains Mr Phillips, as they had been previously selling other firms’ funds of hedge funds. Now they have decided to take the plunge and offer their own products to their clients, but they realise they need outside help to do this.
“As a result of the crisis, these organisations would like to have more control and more transparency, as they believe it is beneficial from their own risk and reputational purposes,” he says. “But if you are outsourcing a fund of hedge funds you need to outsource to a company which has got a very thorough and well-resourced research team.”
The role of the sub-adviser in the hedge fund of fund space involves selecting single hedge fund managers and strategies, allocating between these assets in line with mandate guidelines and carrying out continuous due diligence and monitoring of underlying funds. Essentially a bank looking for a sub-adviser in this area can outsource the whole manager of managers role, explains Mr Phillips, whose GSAM hedge fund strategy group manages around $21bn (€16.5bn).
There is some demand for Ucits III compliant hedge funds. But in that space too investors need to fully understand whether the strategy is conducive to the Ucits III format. This means being aware of any possible discrepancy between the regulated strategy and its offshore version, and monitoring any liquidity mismatch between Ucits regulation requirements – two weekly liquidity minimum – and the actual liquidity of the underlying strategy.
“Ucits III hedge funds is definitely a growing segment of the market with more and more companies entering that space,” observes Mr Phillips. “But it is vital people understand what they are buying, the portfolio risk and how it is managed.”
Firms that seek third-party providers’ expertise to fulfil their product range are today continuously searching for different sources of alpha, which they blend to create the appropriate model portfolio.
“There is very specific demand for emerging market debt, dollar based or local currency,” he says, as there are fewer managers having the necessary expertise to build a product in this area. “We have also seen an increase in people searching for global high yield. Part of that is due to market conditions and the attractiveness of global high yield. But also because the majority of issues are from the US, people may not have that expertise locally.”
There is also growing interest in absolute return products, which can include multi-asset fixed income, for example. Another reason why sub-advisory is popular and growing is because private banks, and not only asset managers, want to create multi-manager solutions, which they use as core building blocks in clients’ portfolios, states Mr Phillips. In US equity, for example, they can blend growth, value, small or mid caps and S&P 500 into their portfolios. Each of the sectors are outsourced to the managers they think are best in the market, who run the assets on a segregated basis.
Sub-advisory, or managed accounts, enables banks to tailor investment solutions to their client needs, control their risk and alpha targets and the asset allocation within the product. It also gives more control on costs, as they know how that cost fits into the overall pricing of the product and they can negotiate the price with the asset manager.
This is in contrast with an off-the-shelf fund, which comes with a set price and has already pre-established risk and asset allocation guidelines, claims Mr Phillips.
“Private banks are looking for consistency in the approach they have with their clients globally, so they build a portfolio depending on their view on asset allocation and client risk profiles. They typically pay an institutional separate account price for the underlying portfolio management skills. They may want to give the manager more freedom or put on more constraints, and they are able to build a bespoke, tailor-made products for their clients, which they think is making the most out of the manager’s skills.”
