I am often asked what the future of Fund of Hedge Funds is. This Monday was no different when as a guest of Resonance 104.4 FM’s Naked Short Club I was asked whether there was a role for Fund of Hedge Funds in the future.
My view is that there will always be a role for Fund of Hedge Funds.
Fund of Hedge Funds fulfil a variety of needs for investors. There are those investors who are unsure of their own expertise and ability to invest in alternative investments, there are others that simply do not possess the resource to conduct the detailed due diligence that should be an essential part of investing in alternatives, there are others who would prefer to leave the monitoring of such investments to those specialising in the area. Other investors view Fund of Hedge Funds as a way of dipping their toes into the world of alternative investments and learning about them as an investment tool, as a way of getting access to investment talent that they may not otherwise be able to invest with or as a way of getting sufficient diversification because of the size of their investments.
Another area that is developing appears to be the appetite for niche Fund of Hedge Funds – specialising in geographical areas or ethical investments. As countries that signed up to the Ottawa convention start to implement versions of their promises – these may provide an impetus for specialised ethical investing that Fund of Funds may be well placed to provide.
Interestingly, more public money seems to be heading into alternatives too as evidenced by tender invitations by national pension schemes for advice on investing in alternatives. Much has been made in the press recently about pension funds acquiring professionals with appropriate experience as trustees of pension schemes and this need becomes ever more important as pension funds consider exposure to alternative investments and look to Fund of Hedge Funds to give them this exposure.
A lot has been written in the press for the need for Fund of Hedge Funds to change to meet investor needs and to allay investors fears on the weaknesses that were self evident in the last 18 months. Alarmingly I see very little evidence of change in the methods used by Fund of Hedge Funds. There is plenty of talk about the changes required: transparency, evidence of process, enhanced due diligence, improved risk management, improved monitoring and reporting, better liquidity management – but scratch beneath the surface of that talk and you will find that little has changed. That is such a missed opportunity – given the role that Fund of Hedge Funds need to play. There is a real need for them. But they need to do more to build the trust of their investors. What I find disturbing is that commercial logic would dictate that they did actively address these issues because ultimately it would stand them in good stead. Yet it does not appear to be happening?
In my view the blame for that lies primarily with the organisational structures employed by the businesses that own these investment managers and the way they are compensated. These encourage a ‘star culture’ around which myths develop, where the focus is more on asset gathering rather than capital preservation. A case where perception becomes far more important than reality.
But blame also needs to be directed at investors who often tend to approach investment with a Fund of Hedge Fund manager passively. When a Fund of Hedge Fund manager talks about their state of the art due diligence process – apply that same process to the Fund of Hedge Fund manager and see if they pass muster. Is there an alignment of interests, are they prepared to provide evidence of what they say they do, do they segregate investment, risk and operational functions, what contingency planning do they have in place when key staff are unavailable and perhaps more importantly do they really have the staff numbers and depth to meaningfully provide the services they are selling. Look for evidence of the risk teams exercising their powers of veto, look at turnover on their various teams and talk to people who have left . Things are rarely as rosy as the marketing people would have you believe.
But for those managers that do get it right. For those that are prepared to be honest about what they can and cannot do and who are prepared to invest in resources that will help them deliver a meaningful service to their clients and who take seriously the delivery of the promises they make – for them there is a future in the long term. For the others, they will get away with what they can in the short term until ‘after the event’ regulation and investor losses result in the imposition of even greater and sometimes pointless costs which will affect everyone in the industry and its reputation. There is a lot to be said for the industry setting high standards that others feel commercially obliged to adopt.
In the meantime the future for Fund of Hedge Funds promises to be interesting.
©Jaitly LLP