Funds of Hedge Funds: Not Dead Yet

(May 2, 2013) -- Funds of hedge funds are dead and buried, aren't they? Not quite, HewittEnnisKnupp has claimed.

The investment consultant has stood up for the much maligned sector in a blog this week, claiming it still has a purpose and are relevant for some institutional investors.

"Contrary to many industry observers, we do not believe that hedge fund of funds are completely on the way out," said Peter Hill, partner and head of Hewitt EnnisKnupp's global liquid alternatives group. "Some of the advantages of using these products include immediate strategy and manager diversification, a more streamlined governance and monitoring model for investors, an ability to customize mandates for larger allocations, access to otherwise closed products, an ability to negotiate terms and fee structures with underlying managers, and attractive risk adjusted returns."

However, this cheerleading for the sector may all be academic. Hill cites the firm's own figures showing its clients have been moving out in their droves.

In 2010, well over half of search mandates from clients were for fund of hedge funds - in 2012 the proportion had fallen to less than a quarter.

An increase in confidence among institutional investors alongside a willingness within the hedge fund community to adapt to these new direct clients' needs has expedited the move out of the sector.

Hill believes either a separate allocation or a combined approach with direct hedge fund strategies can still work well for some investors, if they tick the following boxes: The investment return objective aligns with the typical fund of funds target (e.g., LIBOR plus 3% to 4%); The investment allocation is relatively small (less than $10 million); Hedge fund manager and strategy diversification are important; There is no desire to get involved with the capital allocation process; An additional layer of fees is acceptable; and / or there is limited resource for ongoing monitoring. 

There might be life in the old dogs yet.