Redefining Hedge Funds

(March 1, 2013) — Hedge funds are changing to accommodate institutional investors, and in turn, investors are redefining hedge funds within their portfolios to accommodate them, according to J.P. Morgan Asset Management. 

“Investors have increasingly discarded the notion of hedge funds as a separate asset class and instead are incorporating them into traditional allocations previously reserved for long-only managers,” wrote the authors of a just-released research note. Such investors are starting to classify based on investment characteristics, the paper said, giving themselves more flexibility than portfolios’ finite ‘alternatives’ buckets might allow. 

Notably, the New York-based asset manager’s hedge fund team did not report that this practice of redefinition is happening on a whole-portfolio level, although it may be fostering a change in perspective. 

“They are integrating hedge funds of different styles within traditional allocation categories, such as equity or fixed income, and then looking at the composition of their entire portfolio from a market exposure standpoint,” the authors report. 

And, they said in an email to aiCIO, it’s happening across their institutional client base: “We are not seeing a specific client segment that has redefined hedge fund allocations more frequently. Clients across the investor spectrum that are looking to implement allocations are analyzing risk factors that the hedge funds are exposed to and mapping them to their traditional allocations.”  

Overhauling the asset class model has been a hot topic in the institutional space. A handful of very large institutional funds have made the switch, including ATP, Alaska Permanent, and the New Zealand Superannuation Fund. Many others, including the California State Teachers’ Retirement System, have been considering the idea, often based on advice from consultants. 

“Having a mismatch between our assets and our liabilities was just crazy…Asset classes are effectively dead,” one CIO of a mid-sized corporate pension commented during aiCIO’s recent Influential Investor Forum. 

A fixed-income investment adviser agreed: “An asset-only world doesn’t work.” 

Investment staff at J.P. Morgan themselves see hedge funds as “access points to unlocking excess return via the underlying instruments through which they invest.” 

Based on the current low growth and low interest rate environment, the authors highlighted four strategies offering access to instruments they believe are promising: multi-strategy funds, reinsurance, shareholder activism, and emerging markets.