“The preferred entry-point for institutions is still the fund of funds,” said Mr Smith. “But given last year’s yield of Libor + 3-4 per cent, if you are making your first allocation wouldn’t you rather buy something cheaper?”
Mr Smith observes that, last year, single-manager multi-strategy inflows grew at around one-and-a-half times those of funds of funds “on the belief that it is more fee-efficient.”
According to HedgeFund.net, fund of funds inflows rose 22 per cent for 2006, outstripping inflows to single-manager funds. However, single multi-strategy funds assets were up 35 per cent to almost $200bn (€150bn), having gathered a high proportion of institutional inflows into the single-manager space. New multi-strategy allocations of $38bn in 2006 were over 1100 per cent higher than 2005 and over $1bn more than 2004 and 2005 combined, wrote the report’s author Peter Laurelli.
State Street surveyed US institutions managing more than $1000bn in October 2006 and found that longer-term participants were already switching to single-manager funds “to reduce fees,” and that even new entrants who tend to buy funds of funds are happy to put fewer of them in their portfolios than in the past (the proportion with more than five managers dropped almost a half since 2005).
“Globally, only about 30 per cent of institutions have allocated to hedge funds,” said Mr Smith. “Notwithstanding the number of single-manager funds out there, if every institution doubled their allocation or if the other 70 per cent decide to allocate, there simply wouldn’t be enough hedge-fund trading capacity to absorb it.”
That will mean further development of hedge-fund beta products, such as investable indices like the Credit Suisse/Tremont Hedge Fund Index, or those offered by HFR, MSCI, S&P and Van Hedge Fund Advisors, as well as products that use derivatives to replicate a hedge-fund risk/return profile, such as the Merrill Lynch factor Index, Goldman Sachs’ Absolute Return Tracker Index, Harry Kat’s Fund Creator or Partners Group’s Alternative Beta Strategies.
The challenge for fund of funds providers is twofold, said Mr Smith.
Firstly, they have to continue to demonstrate that they can produce alpha from manager and strategy selection.
But they also have to address institutional investors’ concern to be more involved in the asset-allocation process implicit in making a hedge-fund investment – particularly in the post-Amaranth environment.
MS
