Neuberger’s Ingham: Hedge fund revolution is underway

Fred Ingham

With both bond and equity markets facing major challenges, investors are increasingly seeking out strategies that are not tied so tightly to the performance of the broader equity and fixed income markets.

Over several years the Morningstar and Barron’s Alternative Investment Survey has been showing continued growth in alternatives wrapped in more accessible registered fund structures that offer daily liquidity, as opposed to the more traditional, and exclusive, private funds.

Clearly, the latest developments in alternative investing are as much about investment structures as investment strategies. The survey report notes, for instance, that strong positive flows into multi-alternative regulated funds coincide with dwindling traditional fund-of-hedge-fund assets.

However, some investors still have concerns about alternative investing, with fees and liquidity being the main issues.

Top Reasons to Hesitate Investing in Alternatives

hedge fund

We believe that investors who are moving their hedge fund exposure to regulated strategies without throwing the baby out with the bathwater. Let’s take them one by one:

Fees 

The typical fee for a hedge fund used to be a 2 per cent management fee, with a 20 per cent performance fee. Investing through a fund of funds at peak pricing could have added an additional 1 per cent and 10 per cent, respectively. Competition has brought costs down, but they remain high—and hurdle rates and high watermarks on performance fees add complexity and variability.

While many Ucits still charge management and performance fees at higher, hedge fund levels, some providers are consciously bucking that trend

Redemption terms

Many hedge funds allow only monthly or quarterly redemptions and often include longer-term lock-ups after initial commitments. During the stressed markets of 2008, some hedge funds gated redemptions, only allowing a certain amount of cash to be withdrawn at any one time.

Mutual funds are required to offer daily redemption at a fund’s next NAV. While some of the less liquid parts of credit markets may be out of bounds for funds offering daily redemptions, a multi-strategy, multi-manager liquid alternatives product offering daily redemptions at NAV should have access to a substantial portion of the hedge fund strategies available, minimising selection bias.

Transparency 

Hedge funds often only report to investors once a month, with a delay, and position-level transparency is also not the norm. Multi-manager alternative funds often utilize a separate account structure, as opposed to the traditional fund-of-funds model, and this ensures position-level transparency for the portfolio managers on a daily, or even real time, basis. It allows for greater risk oversight and improves the ability of the portfolio manager to react to changing market conditions.

Additionally, certain regulatory requirements applicable to registered funds require that all securities be maintained at a custodian bank and, therefore, the fund maintains total control over its assets.

Corporate governance 

It is not always clear that hedge fund directors are sufficiently engaged in governance, and in traditional funds of funds investors have little oversight of the selection of prime brokers, administrators and auditors. As part of the comprehensive regulation provided by Ucits, regulated funds’ boards, which include members that are independent of the manager, provide a much-improved governance framework.

For multi-manager funds, they can help improve the process of monitoring the underlying managers and often allow the fund, and not the underlying managers, to select and directly oversee other fund service providers.

Encouraging trend

The fact that more and more products are being rolled out to fit this investor-friendly profile is encouraging.

This reflects an increasingly competitive hedge fund industry. Managers are both more willing to adapt their hedge fund terms to match those of regulated funds and more willing to launch regulated funds to access a bigger pool of investors.

This is happening largely without injurious hedge fund-style terms being smuggled into regulated fund structures, or the watering down of hedge fund strategies. That is why we believe this growing phenomenon has earned its distinguishing descriptor – liquid alternatives. 

Fred Ingham is head of international hedge fund investments at Neuberger Berman