Multi-Manager v. Multi-Strategy: The Hedge Fund Debate

(May 12, 2014) — Investors should think long and hard before committing to a multi-manager hedge fund over a multi-strategy one, according to a Cambridge Associates study.

Multi-manager funds, defined as those with capital allocated to numerous “investment teams based on their anticipated performance,” are often accompanied with highly attractive qualities including high returns, fewer drawdowns, and low beta, the consulting firm argued.

As such, multi-manager funds have been gaining popularity, especially since the financial crisis. According to the consulting firm’s report, approximately $15 billion was placed into the 10 largest multi-manager funds from January 2009 to June 2013. On the flip side, the 10 largest traditional multi-strategy funds witnessed net outflows of 20% in the same period, bringing total assets under management down to $140 billion.

“Part of this divergence can be attributed to industry-wide factors that revealed a flaw in the management of some traditional multi-strategy funds—they became increasingly exposed to strategies that fell outside the managers’ core areas of expertise, specifically by investing in highly illiquid securities,” the report said.

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During the financial crisis, funds heavily invested in illiquid assets took a hard hit—such as multi-strategy funds—resulting in a crash in Sharpe ratios. Multi-manager funds, not designed to withhold such volatile and illiquid strategies, were able to avoid negative impact from the market environments in 2008 and 2009, according to Cambridge Associates. This was also in line with the way multi-manager funds derived a majority of their returns from equities.

Multi-manager funds were also able to secure “high-profile investing talent” over the past few years, the report found, largely due to attractive compensation and the ability to avoid high start-up costs.

Despite these appealing qualities, investors should be wary of high investment fees and frequent turnover of traders within investment teams to ensure the firm is appropriate for their needs.

“Multi-manager firms tend to be quick to fire trading teams when they underperform,” the report said. “While this practice may help to subdue losses in the fund, the turnover also means that it is particularly difficult to anticipate the future sources of fund returns.”

The high turnover rate could also contribute to a loss of opportunities to grow assets at a lower cost, the report continued. Since the fund need not pay incentive fees to the trader until the trader offsets previous losses, the investors may be hurt short-term from these less profitable traders.

Fees were reported as being considerably more expensive for multi-manager funds than traditional funds, the report found. Unlike the fixed fee structures of traditional funds, multi-manager funds could rack up management fees and investment-related expenses in addition to incentive fees.

However, according to Cambridge Associates’ analysis of historical returns, the more expensive funds generally outperformed the inexpensive funds on a risk-adjusted basis. A caveat, though, was that the average multi-manager fund needed to earn 40% higher profits for investors to experience the same net return as with an average traditional multi-strategy fund.

“While this is a broad generalization that ignores different uses of leverage, we find it generally consistent with multi-manager firms’ tendency to place more stringent return expectations on its traders,” the report said.

(May 12, 2014) — The trend away from equity investments in real estate could hit a milestone this year, as debt becomes a favoured option for many, data has shown.

In 2013, for the first time in more than five years, closed-end funds offering solely equity options for real estate investors accounted for less than half of the capital committed to the sector, data monitor Preqin has found.

Just 49% of the billions of dollars earmarked for the sector went into equity-exclusive funds in 2013, down from 69% in 2009. The majority of assets headed for funds offering just debt, or a combination of the two options, for the first time in five years. This trend towards debt, or combined debt and equity funds, has been maintained over the last five years, despite a blip in 2012.

“Aggregate capital raised by primarily debt-focused funds [decreased] from a signiﬁcant $13 billion for funds closed in 2011 to $5.6 billion in 2012,” said Preqin. “However, 2013 saw capital raised for this strategy more than double to $12.2 billion and 2014 so far has already raised more than this, with $13.2 billion raised from 10 funds. As such, fundraising for debt-focused funds appears to be gaining momentum as investor conﬁdence in the strategy increases leading to greater amounts of capital ﬂowing into such funds.”

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One of the reasons behind this change has been the better returns being made from debt investments. Since December 2007, Preqin’s Real Estate Debt Index has outperformed both the Value Added and Opportunistic indices. The returns, rebased to 100%, are shown on the chart below.

Asset managers and other providers have realised the move too. The number of options being offering to investors this month—some 53 primarily debt-focused funds—has doubled from 26 in 2010. They are also targeting more than double the assets: $22 billion, up from $10 billion.

“This increase demonstrates that fund managers were quick to capitalize on the large opportunity to invest in real estate debt resulting from the retreat of traditional market lenders,” Preqin’s report said.

However, investors should be aware and carry out thorough due diligence on their potential new partner, the data monitor warned: “The relatively recent emergence of debt as a strategy for private real estate funds also means that a large proportion of managers raising debt funds have limited experience regarding the strategy, despite many having long track records in the private equity real estate space. Seventy percent of capital targeted by debt funds in market is by managers raising their ﬁrst debt fund.”

Preqin real estate