Goldman Sachs Asset Management is doing fine, thank you very much.
Clients continue to invest in hedge funds via Hedge Fund Strategies — Goldman’s fund of funds unit within the $65 billion Alternative Investments & Manager Selection group — despite bad press for the bank generally and a backlash by many investors against the fund of funds model.
In fact, the fund of funds unit has consistently grown its business since the financial crisis and through its public relations debacle stemming from now-settled Securities and Exchange Commission allegations of misleading clients. Since early 2009, Goldman’s Hedge Fund Strategies assets have increased roughly 13% to around $21 billion in assets today (the bank does not comment on performance or even name specific funds).
Goldman says its fund of funds team is the “largest, deepest, and strongest” in its long history, with more than 100 professionals, 40 of them on investment and risk management teams, across ten offices around the world, not to mention the broader resources of AIMS and GSAM, which manages $802 billion all in as of June 30, including private equity investments and proprietary hedge funds like Liberty Harbor and Goldman Sachs Investment Partners.
Still, things haven’t been perfect. Despite steady fund of funds performance, high personnel turnover has caused at least two big investors to rethink their relationships with the bank.
The $22 billion Texas Permanent School Fund plans to pull out of a $500 million fund of funds mandate and the $4 billion Philadelphia Public Employees Retirement System killed a $25 million fund of funds investment with the financial powerhouse because of recent turnover.
That includes the departure of at least seven senior professionals from Goldman’s Hedge Fund Strategies group over the past four years. Most recently in May, Jeff Blumberg, a managing director in London responsible for Europe and Asia, left to be Egerton Capital’s chief operating officer. (In response, Goldman says “there’s always some natural evolution in a long-standing business in a dynamic industry”).
And while Goldman’s Hedge Fund Strategies arm continues to hold on to about $21 billion in assets overall, the money in one of its main institutional fund of funds has declined.
The Goldman Sachs Hedge Fund Partners fund had about $1.92 billion in assets under management at the end of March. That’s compared to $3.26 billion at the end of 2007, $2.25 billion at the end of 2008 and $1.97 billion at the end of 2009. (The bank says the fund is “one small slice” of the overall business and that many investors moved money to a more concentrated strategy and therefore the fund's asset drop doesn’t represent a decline in assets).
The Partners fund returned 9.3% for twelve months ending in April, -4.11% for the last two years and 4.16% in the last five years, according to investors.
But in a rare on-the-record interview with AR, Goldman remains positive about its hedge fund offerings and the case for fund of funds generally.
AR recently spoke with Kent Clark, a managing director and head of AIMS Hedge Fund Strategies and co-chair of the HFS investment committee and Chris Kojima, also a managing director, and co-head of both AIMS and Global Portfolio Solutions.
Clark and Kojima discussed their outlook for the hedge fund industry generally; their preferred strategies; the continued case for fund of funds; and whether Goldman Sachs’ broader image problems have hurt their business.
AR: Does HFS invest in any of Goldman’s internal hedge funds? If not, why? What is your policy? Please explain the conflicts issue.
Kent Clark: Since our clients have direct access to internal Goldman Sachs’ funds, the AIMS Group as a policy matter does not invest in any Goldman Sachs’ hedge fund or private equity funds. Most of our clients partner with us to source and evaluate external managers, and to design portfolios and risk management solutions around these diversified investment options.
Congress just passed a law
limiting banks’ ability to invest in hedge funds and private equity. Does that affect your fund of funds offering? If not, why not?
Chris
Kojima: Our investors are among the world’s leading pension plans,
sovereign wealth funds, financial institutions, endowments, foundations, and
families. Essentially all of the capital in our AIMS hedge fund program is from
these institutional and individual clients, for whom we serve as
fiduciaries.
Given the tumultuous changes in the industry, how do you expect hedge funds to change in the future?
KC: The outlook is still positive but different than what we’ve seen over the past 10 years. The fundamental value proposition of hedge funds is to deliver returns that are attractive but to some degree unrelated to more traditional or easy to manufacture returns. We believe that is still the case.
The twist is that, more than ever, getting better returns in this space will require careful manager selection both on an investment side—to get the good returns and avoid the poor returns—as well as on the operational due diligence to avoid the ticking time bombs since there really isn’t any return upside to go along with operational problems.
In thinking about some of the things to watch out for, there are still a large number of managers who are below their high-water mark and maybe have been for some time now. They may be coming up on three years without collecting an incentive fee. One thing we are cautious about is managers who may not have the economics to keep their teams together in their current format.
The industry, and the use of hedge funds, is evolving. Rather than be a bucket that sits to the side of everything else—95% traditional, 5% hedge funds—we’re seeing that different styles of hedge funds are finding their way into parts of the portfolio that are adjacent to similar risk factors. An example of that are equity long/short managers. We’re seeing those kinds of managers being used increasingly by institutions as a portion of their equity allocation.
What about the future of funds of funds? Are clients now more skeptical about the value they can offer?
CK: That really hasn’t been our experience. In fact, investors we’re talking to today have an even deeper appreciation of the need for thoughtful manager selection, portfolio construction and risk management. This comes partly as a result of 2008 volatility, partly as a result of some well-publicized manager-specific challenges. Today, there’s a full understanding of how difficult these activities are. Looking back, in ’05, ’06, ’07, when everything was seemingly going well, the difficulties were perhaps not as apparent.
In recent years, many institutional and individual investors have been confronted with so many challenges all at once: spikes in volatility, unforeseen correlations, hidden illiquidity, significant drawdowns. In some ways, if you can have a broader discussion — not so much selling a product, but having a thoughtful conversation about the place of hedge funds, asset allocation, risk management — that’s just a welcome conversation. Whether it leads to Goldman-specific funds is another question, but we always welcome the discussion.
In the past few years, have you been able to negotiate better terms and fees with the hedge funds you invest in?
KC: We are constantly exploring the ideal array of terms with underlying managers. And these terms are not only economic — they include terms governing liquidity, transparency, mandate, key-person, affiliate transactions, among other things. Of course, this isn’t a one-size-fits-all approach. Judgment, informed by extensive manager-specific diligence, is needed to determine what is appropriate.
With respect to your firm specifically, how has the publicity surrounding the SEC’s charges against Goldman affected AIMS?
CK: The investors we’ve had the privilege of working with often have had relationships with us for many years. I’d say the client support has been very good. We’re fiduciaries for our clients, full stop. In some cases, the recent conversations we’ve with clients have taken the form of education and clarification, where we’re ensuring they understand what it is we’re doing for them, and what we’ve always done for them. And that is to serve as their fiduciaries as we deliver them solutions for their hedge fund investing programs.
You say there hasn’t been a material impact, but haven’t some people redeemed?
CK: Investors are always managing their portfolios, and so there will always be some redemptions and new commitments. Since early 2009, we’ve seen our assets increase around 13%, and today we’re around $21 billion in assets.
Is that from fund performance of capital inflows from investors? How much from each?
KC: It is from a combination of inflows and market appreciation but we don’t break it out.
Our focus is consistently on investment performance and risk management and client service. If we perform well, our belief is that the business will continue to grow.
Have you altered your terms for investors following the financial crisis?
CK: We continually re-evaluate terms of underlying managers and the way we deliver solutions to investors. The financial crisis has forced many investors to consider fundamental questions about asset allocation and risk management. We’ve been working with investors to help them look at their portfolios from a variety of perspectives: Liquidity versus illiquidity, inflation versus deflation, developed versus growth markets. It’s critical to look beyond traditional classifications and focus instead on how the portfolio behaves across different scenarios. Part of this analysis involves a thoughtful review of terms of the underlying managers, including transparency, liquidity, and economics, and we are constantly re-evaluating terms. But this is only part of the whole equation. The focus needs to be on risk management, not just risk metrics.
Why shouldn’t investors go direct into hedge funds, as many are doing? How have you made the terms better for me?
CK: There are some institutional and individual investors that have the expertise, resources and ongoing commitment to select managers and to monitor these managers. But this requires a global sourcing network, an extensive due diligence team, market insights, deep risk management capabilities, legal resources, and technology infrastructure. Some investors looking at hedge funds want to partner with us to fully access our capabilities. Others want to complement their own resources. We’re pleased to engage with investors across this entire spectrum.
For those investors with an internal team, we often partner with them on specific niche strategies. Let’s say they are very well resourced in the U.S., but in Asia or Brazil they do not have people on the ground. Or have good coverage of equity long/short managers, but have less expertise in credit strategies. We might help amplify their capabilities in those areas. Alternatively, on their entire portfolio, we might engage with them in an advisory capacity and offer our insights as a supplement to their own. The terms, structures, and economics can be highly customized in such arrangements.
Do institutional investors have realistic expectations about hedge fund performance?
KC: It’s not clear that many investors have realistic expectations for traditional asset classes, and that’s something that has to be the core of what types of returns you think you can generate from anything else.
A lot of this comes back to the issue of understanding whether historical track records—and many of them are quite impressive—are truly representative. That, for me, is one of the bigger questions, to see if people are actually looking at the relevant track record. It’s not just that there was this great track record historically and I need that return to fit into my portfolio assumptions going forward. The question is, is that something that’s sustainable in the current environment?
It’s reasonable to think that, depending on the strategy, returns may deteriorate over time for some strategies that are characterized by being smaller and more limited in supply, just because the demand for those returns generally rises to basically take away any extra alpha.
But there are a couple of mitigating factors. One is continued innovation, which creates new opportunities to create attractive returns. The other is that there are some strategies where, just because of the size and depth of the markets and the liquidity of those markets, there is no real reason to believe that the alpha or return opportunity really goes down over time.
There are some strategies where we expect similar returns to what we’ve seen in the past. There are other strategies that will probably have more of an ebb and flow where they’ll go out of favor or their returns will just diminish and then there will be new strategies that will come up and take their place.
Which strategies do you like most right now?
KC: We are probably distinctive in our allocation to macro-style managers and the length of time we’ve been investing there and probably the amount of size we have there. In terms of percentage of dollars, it tends to be about a quarter of a diversified portfolio of assets.
What we think is attractive is the amount of dispersion we’re seeing globally in policy and the uncertainty that we’ve seen in economic prospects, and that essentially has created opportunities for macro managers over the course of the past 18 months. We expect it’s a situation that should persist for some time. Macro managers certainly have the broadest view of the world. They tend to be agnostic with respect to direction, so you don’t find a macro manager who biased to be long equities or long dollar versus euro. They are very much trading long and short.
What are the prospects for long/short equity funds?
KC: With equity markets, there are certainly going to be winners and losers within industries and across countries, which creates opportunities. We think that with long/short managers—although they’ve had a relatively muted year so far—there are attractive opportunities to some extent created by the market downdraft but also just based on valuations.
There are certainly long opportunities. And there are certainly still companies that have potentially questionable business models or uncertain futures, so there’s the ability to be long and short. Long/short is probably at a high level of allocation for us because of what we perceive to be the opportunity for alpha and dispersion of returns going forward.
What about less liquid strategies?
KC: There are events and event driven-type managers that should have the opportunity to play out with very positive results over the next year or so. There’s plenty of cash on corporate balance sheets and that can drive changes in structure, like M&A activity. It can drive share buy-backs, which can be a catalyst for value realization even in just a traditional long/short equity strategy. So we think that managers who are playing toward a specific event and are less likely to be subject to broad market events offer a good opportunity for value added as well.
With credit, in spite of all the volatility and all of the beta-driven moves in the markets over the last couple years, for managers trading in the mid-market, away from the largest-cap opportunities, there continue to be enough opportunities for the mid-sized managers playing in that market to make good returns.
There’s still fallout from where we’ve been the last couple of years and there’s still plenty of uncertainty about the robustness of balance sheets—and in some cases business models—that selectively there could be real opportunities with credit managers.
Are there any strategies are you avoiding?
KC: Some we always avoid are ones where their return proposition seems to be almost entirely predicated on the use of leverage, which is different from saying we don’t invest in managers who use leverage. But managers that are trading very small spreads, where the only way you can get reasonable returns is by gearing them up, are ones we tend to avoid.
Strategies where there is real illiquidity accompanied by leverage or even just real illiquidity we’ll avoid as well. There are some strategies that could be reasonable as part of a multistrategy firm but we don’t want to see on a standalone basis just because they have episodes where they have great payoffs and episodes of being quiet or just unattractive. Often, multistrategy managers will make the allocations opportunistically rather than always having to be invested.
Examples of things we don’t do on a standalone basis are convertible bond arbitrage and private investment in public equities. Those can be part of a broader mandate but are not something we would do in a dedicated way.
Additional reporting by Anastasia Donde