"For funds of funds to succeed they are going to have to change the way they do business," particularly if they are to attract money from larger investors, believes Brian Altenburg, a managing director in alternative investment asset management at Bank of America. This evolution is likely to focus more on valuable transparency, managed accounts and strategy-specific funds. Established managers that manage to do this will take more market share "than those who just keep business as usual," said Altenburg.
Part of the problem is that larger investors such as pension plans are increasingly switching from fund of funds exposure to single-manager investing, following the bad press that funds of funds managers have had, Olivier Cassin, head of research and development at bfinance in London, told AIN. The Bernard Madoff debacle showed that the so-called due diligence process was for many firms "more marketing than something they're following on a day-to-day basis," added Altenburg.
Cassin believes that for funds of funds to interest larger investors they will have to reinvent and differentiate themselves, perhaps coming up with more niche offerings to justify their role. Altenburg sees them evolving to offer funds based upon a single strategy type, such as event-driven or long/short equity, rather than the traditional multi-strategy model. These would be relatively concentrated portfolios, holding 10-15 managers.
This would allow investors to customize and diversify their portfolios at the asset-allocation level, choosing to invest 40% in CTAs for example, or 25% in credit, said Altenburg. The role of the fund of funds manager would be to provide diversification and selection at the individual manager level, he explained. As gaining access to star managers in no longer an issue, funds of funds may also focus on the ability to identify talented managers early on, said Cassin.
While Altenburg commended calls for more transparency, he noted that this can be misguided--information is only valuable if it can be efficiently evaluated. He believes that funds of funds need to put the "proper types of analysis and reporting in place," to evaluate correlations and overlap, for example, to give investors the full benefit of transparency, and "very few will do that."
"It's easy to criticise fund of funds investing for an investor and think they can do it better," said Cassin but this may be problematic later on. Cassin told AIN that he knows of a family office, for example, that was hit worse than its peer group last year because of its direct allocations to hedge funds and said that for those investors that move into direct investing, "there's a high chance they'll get hit by the next crisis, whenever and whatever that is."
Altenburg agreed, noting that larger managers that choose direct allocations to hedge funds are "almost building their own fund of funds portfolio"--this can create problems in itself, such as inadequate diversification.
--H.A.
This article was originally published in Alternative Investment News.
