While the hedge fund industry is showing healthy signs of recovery, hedge funds of funds are still facing significant redemptions this year. It is undeniable that the raison d’être of funds of hedge funds, which lies in their ability to carry out a rigorous due diligence and pick the best managers, has been put under severe scrutiny during the financial crisis, as many of them were invested in Madoff strategies. Illiquidity and lack of transparency have become major issues for investors, who increasingly prefer to use hedge fund advisory platforms to funds of hedge funds, as they want to be more involved in the fund selection process.
Moreover, the modest performance generated by funds of hedge funds, just 2 per cent on average year to date, is certainly not very attractive.
The priority for hedge fund managers is today to focus on very liquid, transparent and flexible strategies, to meet client demand and adapt to the uncertain environment.
“What we think is attractive in the risk reward space is allocating across all styles of managers who are very liquid and very transparent,” says Anthony Lawler, head of portfolio management for Man’s $14bn (€10.5bn) multi-manager business. “Part of the reason for that is that we feel uncertainty in the world is still underpriced in the markets. We are still in a financial crisis that keeps evolving, credit availability is still restricted for middle market companies and consumers, but the governments are pouring very significant amount of capital into the system to try to increase growth rates and economic activity. We believe there is uncertainty in what the outcomes and the path of asset prices are going to be.”
Man’s preference is for proven, nimble traders, who can change their positioning very quickly, such as global macro traders or long short traders who have a history of going completely cash or going net short, if they need to, explains Mr Lawler.
A growing number of funds of Ucits III hedge funds are now being launched to respond to increasing client demand for higher liquidity, transparency and regulatory oversight.
A fund of Ucits hedge funds is the latest addition to Schroders’ regulated hedge funds platform, Gaia, which has gathered around $400m of assets since its launch more than a year ago. The fund, which is the regulated version of Schroders’ offshore fund of hedge funds with eight year track record, was launched largely in response to client demand, explains Gavin Ralston, global head of product at Schroders.
“Most offshore products still operate with either monthly or quarterly liquidity but there is a large client base that wants the ability to access their investments more frequently than that,” he says. “What is key is that we make sure the liquidity terms of the fund of funds are aligned with the liquidity terms of the underlying hedge funds we invest in.”
One of the main issues in the Ucits III space remains the limited size of the industry. Greater diversification in terms of manager and higher returns is needed, states Pascal Botteron, global head of the fund research group at Deutsche Bank. While the hedge fund industry can count on 200 to 500 good hedge fund managers, depending on research criteria, in the Ucits III industry there are currently around 20 good names. As a consequence, the 60 funds of Ucits III funds currently available are doomed to have similar allocations.
Deutsche Bank currently offers three different lists of absolute return funds, including standard hedge funds, managed by around 50 managers, managed accounts, sourced from 25 managers, and Ucits III absolute returns run by a mix of 25 managers in the long only and hedge fund space, as the mutual fund and hedge fund research at the German bank are run by the same team. Mr Botteron highlights a difference on the average performance between the three platforms. Year to date, standard hedge funds are the best performers, while managed accounts and Ucits III are behind by 26 and 170 basis points respectively. The gap can be attributed to different factors, such as Illiquidity premium, instruments available or leverage.
Defensive strategies
The lower performance of Ucits III funds observed in the market can be partly explained by the fact that a few of the managers are managers operating defensive strategies, almost cash plus strategies. Also, it has to be taken into account that some of the first movers in the Ucits III space were more conservative to adapt to the new regulatory environment, explains Mr Botteron.
The key challenge for the Ucits III industry is to boost performance to attract more investors and a portfolio manager needs to compensate for the underperformance of Ucits III funds with active management to add alpha, he says. In six months, as more managers come to the market, the performance gap between onshore and offshore hedge funds will decrease, expects Mr Botteron, as it has decreased over the years the performance gap between offshore funds and managed accounts.
