The Whole Foods Approach to Investing | Chief Investment Officer

To be truly long-term investors, asset owners must understand the ingredients in the financial products they are consuming, according to research from Stanford University’s Global Projects Center.

Today’s complex financial systems have allowed asset managers to obscure the fees and costs they charge to asset owners, argued Global Projects Center Executive Director Ashby Monk and Research Associate Rajiv Sharma. This obfuscation of costs has in turn distorted the economic incentives that drive capitalist markets, leading to an “increasingly short-term and disconnected financial world.”

“Most long-term investors are not exercising their long time horizon effectively, preferring to work through short-term oriented intermediaries,” Monk and Sharma wrote. “It is this short-termism that creates a variety of market failures and contributes to an unhealthy form of capitalist development.”

“It is this short-termism that creates a variety of market failures and contributes to an unhealthy form of capitalist development.”Comparing the financial system to the food industry, the researchers explained that the mass production of investing has led to the development of products that barely resemble the underlying assets.

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“Just as in food, a financial product can, quite literally, be ‘packaged’ and ‘wrapped’ and sold to consumers looking to satisfy a specific return need with very little understanding of the ingredients that are meant to deliver those returns,” they wrote.

To solve the problems of short-termism, Monk and Sharma prescribed a Whole Foods approach: Rather than settle for “junk food,” which is cheap and easy in the short run but can be detrimental to long-term health, asset owners should buy organic—or invest in a way that is “sustainable, healthy, and long term.”

Such investments could include allocations to infrastructure or green technology, as well as venture capital investments that back entrepreneurs and new businesses. However, many long-term investors currently don’t participate in these markets because they are “either convinced that some other short-term strategy better meets long-term needs or they simply don’t understand how to access these assets,” Monk and Sharma wrote.

But if fees and costs were made transparent, Monk and Sharma argued those same investors will quickly see that “organic” products are in fact better for them in the long run.

“It is only in recognizing the true ingredients, and their incentives, that long-term investors will finally organize themselves to consume ‘healthier’ products,” they concluded.

Endowments and foundations tend to use more funds-of-hedge funds than their family office counterparts, according to Preqin.

The data firm found 30% of endowments and 27% of foundations invested through funds-of-funds, compared to just 5% of family offices.

Family offices strongly preferred investing directly, with 71% targeting single-manager funds. Endowments and foundations choosing direct investments lingered at 37% and 35%, respectively.

While long-short strategies were popular among all three investor types, a larger proportion of foundations (78%) invested in them. Just over a third of endowments and foundations also had exposures to credit strategies, while only 21% of private wealth managers showed preference.

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Preqin also found investors most favored North America-focused hedge funds, “which is unsurprising given that North America is home to the majority of these investor types.”

Some 85% of endowments and foundations said they preferred North American funds, compared to 60% of family offices.

More than 90% of endowments and foundations were also likely to target global opportunities in their hedge fund allocations, significantly higher than 64% of private-wealth investors.

Despite differing routes to hedge funds and 2015’s disappointing returns, Preqin added investors are “likely to be active in the hedge fund market over 2016.”

Deutsche Bank’s recent alternatives survey echoed this sentiment, with 91% of investors increasing or maintaining their allocations to hedge funds in 2015. Some 41% said they planned to increase their exposures in 2016, while 48% said they intended to keep it at the same level.

“The return dispersion seen in 2015 means that choosing the right manager and constructing the right portfolio is ever more critical,” said Anita Nemes, Deutsche Bank’s global head of capital introduction.

Mercer also emphasized in January that nonprofit investors should scrutinize their hedge funds and lower than expected returns despite strong equity markets in the past seven years.

Preqin E&F HF