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In association with Hedge Fund Intelligence |
Hedge funds have faced a lot of criticism over the past year – as many have struggled to cope with the global financial crisis and faced heavy redemptions. A clear majority have delivered negative returns. As I have argued here before, though, not all of this criticism has been deserved. Hedge funds should not be blamed for the onset of the credit crunch; a significant minority have continued to deliver positive returns; and the industry as a whole has still outperformed other risk assets such as equities and real estate/property. But we all know it has been a very difficult time and that conditions continue to be very challenging.
The part of the industry that has had arguably the most opprobrium heaped upon it during this tumultuous period has been the fund of funds sector. While the mean returns from the single-manager universe were deeply disappointing at about minus 15% last year, the InvestHedge Composite showed that the median return for funds of funds – after their extra layer of fees – was of course even worse at minus 16.63%. And, unlike at single-manager level, only a small minority of multi-manager portfolios – mostly those with a focus on specific strategies such as managed futures or macro – were up for the year.
Failed to deliver
It was a year when the much-vaunted diversification benefits of the multi-manager approach in most cases simply failed to deliver. And to add insult to injury, the year ended with the revelation of the Madoff affair – which also made it plain that all too many supposedly sophisticated allocators had not been clever enough to avoid the world’s biggest-ever Ponzi scheme.
It would be surprising, therefore, if all of this should not lead to some serious soul-searching within the industry – about whether the fund of funds model itself is irrevocably broken; whether it needs to be reinvented; and, if so, how?
There are clearly a lot of lessons to be learnt from 2008. But, at the risk of flying in the face of the conventional wisdom, I would stick my neck out and say this is certainly not the end of the road for the multi-manager approach.
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I would stick my neck out |
For one thing, the statistics show that it is still an industry of substantial scale. The latest numbers on the InvestHedge Billion Dollar Club show that there are still 137 funds of hedge fund groups with assets of $1 billion or more – and with collective assets of some $744 billion at the end of 2008. This is down sharply – by about 30% from $1.1 trillion in mid-2008 in a period of only six months. But when you also add in the assets of the 420 or so smaller multi-manager groups, it is clear that about half of the $1.8 trillion still being managed in hedge funds is being allocated via the fund of funds route. As Niki Natarajan, editor of InvestHedge, put it most succinctly: “The industry has taken a serious beating, but it is not an industry that is on the brink of extinction.”
It seems certain that there will be consolidation – as the boutique players who cannot differentiate themselves in a crowded market decide either to fold up or to team up with others. But it seems to me that some niche players will still remain – as there will always be a need for those who can identify the skill-sets required in specific areas such as emerging markets or commodities.
Again, I concur with Natarajan’s conclusion: “A clear-out was necessary as there were too many sloppy practices in the industry. Everyone, large or small, is going back to the drawing board to make sure that their business can stand the highest level of scrutiny.”
Not surprisingly, many expect that those that had exposure to Madoff will have a harder time – though for some, such as UB P or RMF, the exposure was so small out of a massive pool of assets that they should be able to overcome it. In this context, it is worth noting that only about 30 fund of funds groups – out of 600 or so firms on the InvestHedge database – are known to have had exposure to Madoff.
Thousands of other investors, including many high-net-worth individuals, foundations and charities, went direct or via feeder funds. And when the dust settles on the Madoff affair, it is not clear to me end-investors will conclude that the best way to invest in hedge funds is to go direct and cut out the middleman.
Madoff exclusion zone
InvestHedge held its annual awards dinner in mid-March, as usual again in New York. The attendance was a little down on previous years – from about 400 to just over 300 this time – which is not surprising following a year of generally negative performance. But again this does not appear to reflect an industry or sector that is suddenly about to disappear.
For the awards this time, InvestHedge took the extra precaution of ruling out of contention any fund that had exposure to Madoff – though, given the quantitative methodology used, it is worth noting that hardly any would have featured anyway. More interesting, and worth noting, is that only one of the 20 winning funds from the previous year had exposure to Madoff either – which appears to show that the methodology, while designed to reward those that achieve a smoother return profile, had also managed to weed out those that tend to make the wrong sort of allocations.
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In association with Hedge Fund Intelligence |
