According to prime brokers in New York and London, funds of hedge funds are reducing the number of new managers they are taking on their books, and, in some instances, are reducing their existing portfolios of managers. One prime broker says that some funds of hedge funds have reduced their books of managers by 10% to 20% over the past two quarters.
Vineet Kapur, co-head of North American prime brokerage capital introduction at Morgan Stanley, says his firm has noticed this trend. “We have seen funds of hedge funds decreasing the number of managers on their books, and allocating the extra money among their top existing managers,” he says. Increased capacity among the largest and most successful hedge fund managers has enabled investors to put more capital to work with its best-of-breed base. Kapur says that very few top managers are closed to new money.
In addition to giving them the ability to tell end investors that allocation is truly with the best in class, funds of hedge funds are being swayed towards taking on fewer new managers for several reasons, says Kapur.
Reduction
“If a fund of hedge funds has only a small holding in a manager, and does not want to grow that position, or the underlying manager is not itself growing, then ceasing to invest will free up due diligence time and costs that could be spent on a manager whose positive performance will really impact a large portfolio,” he says. There is also the benefit of reducing the 20% performance fee by eliminating managers that offer no diversification benefits.
Mehraj Mattoo, global head of alternative investment strategies at Commerzbank in London, disagrees that there will necessarily be a decrease in the number of managers deployed, but concurs that new managers will find it harder to attract funds of hedge funds as investors. “In the current market conditions, unproven talent is less attractive, and investors would not want to take excessive risks. You are more likely to want to stay with managers that have proven they can weather the storm,” says Mattoo. “Investors are going to use last year’s market conditions as a litmus test for the efficacy of managers who can make money in markets characterized by dislocations and not just in bull markets. Managers that did well are certain to see new asset inflows.”
Increased allocation
Nedgroup Investments’ fund of hedge funds has increased its allocation to existing managers, although it is still investing with new managers. Managing director Andrew Lodge says that diversification is essential. “We’ve increased allocation to managers that were previously closed but we want to hold a good spread of managers,” he says. “Otherwise, the fund can become too directional and too exposed to a particular strategy.”
Lodge warns that due diligence of existing managers is still important, and perhaps increasingly so. “If managers are opening up for new capacity, we need to know why,” he says. “Do they now have room because of redemptions? And what is the pattern of redemptions over the last six months?”
A survey of investors by Deutsche Bank released last year showed that most respondents had reduced the number of new allocations to hedge funds from 13 to 10 year on year.
