Leading institutional investors increasingly see themselves in partnership with their hedge fund managers, according to a new report from Barclays and the Alternative Investment Management Association (AIMA), and both sides enjoy the benefits of greater knowledge sharing and customisation of services.
‘The Extra Mile: Partnerships between Hedge Funds and Investors’, represents the first collaborative effort from Barclays’ capital solutions team, which publishes frequent hedge fund industry reports.
It was based on interviews with 30 investors, responsible for $2trn (€1.5trn) of assets and $260bn of hedge fund investments, the majority of which sit on AIMA’s Investor Steering Committee.
The sample was globally diversified – 40% were pension funds and a further 17% were consultants.
The hedge fund managers interviewed were, in some cases, singled-out in the investor interviews as leaders in the partnership trend.
In the foreword to the report, Michelle McGregor-Smith, chair of the AIMA Investor Steering Committee and chief executive at British Airways Pension Investment Management, said: “What we have found is that investors are increasingly striking up partnerships with hedge funds.
“These partnerships take many forms, including the sharing of knowledge, the building of more customised products, co-investment, product seeding and equity investment.”
Ermanno Dal Pont, head of capital solutions for Europe at Barclays, sees the partnership theme as a natural outcome of the institutionalisation of the hedge fund client base over the past 15 years.
“Institutional investors see hedge funds as ‘centres of excellence’ – identifying specific risks they want to take and then looking for excellence in those risks within the hedge fund industry – and real partnership is seen as an opportunity to improve their own investment practices,” he said at the launch of the report in London.
“By thinking about hedge funds in these terms rather than as a range of products, they also enhance the ability to create tailored strategies. All of this is seen as a way to extract more value from the managers for the fees they are paying.”
As one $100bn pension fund put it: “The ability to get portfolio managers on the phone once a month and share insights is very important – it helps us figure out what our next investment is going to be.”
Jack Inglis, chief executive at AIMA, added that he was encouraged by the trend.
“These arrangements represent a win-win for both sides, with significant benefits for both the manager and the investor,” he said.
Hedge fund managers value the stability of partnerships because theirs is a much more volatile business than traditional long-only asset management, but they also see the ability to offer genuine partnership as a valuable differentiator.
Pro-active client servicing, backed-up by genuine understanding of investors’ needs and managers’ capabilities, is regarded as necessary but not sufficient for maintain real partnerships.
Managers need to show they are thought leaders in their area of expertise by publishing research that sets the agenda for the client base.
“If you don’t show me you have the expertise, you will not be the firm I go to with my problems or challenges – you are not a potential partner,” as Dal Pont put it.
He cited one investor that identified a particular manager for its risk management excellence, and asked the chief risk officer to audit its own processes and systems.
More than half of the institutions interviewed mentioned the importance of managers being able to offer either co-investment (in illiquid opportunities) or customisation (of more liquid strategies).
“This is really at the core of what partnership means,” said Dal Pont.
The partnership theme is most important for larger multi-strategy, macro or fixed income managers, but Dal Pont emphasised that boutiques and managers of niche strategies still had a role.
Indeed, he pointed out that some of the largest and most sophisticated institutional investors say the most valuable expertise comes from these managers precisely because they already have many of the other capabilities in-house.
It is a different model of partnership – a smaller staff means less emphasis on demonstrating thought leadership, but a smaller client base can facilitate more access to portfolio managers.
“This is not a free lunch,” Dal Pont said. “If you want to develop partnerships with investors, you will have to invest – in staff, in research, in enhanced client service and risk management.
“For that reason, you need to be careful to focus on those elements of partnership that work well with the kind of business you are and the types of strategy you offer.”
Not all hedge fund managers see a role for themselves in the partnership theme – about 25% of those interviewed downplayed its importance.
Among these, most said that, because they could not practically be partners with all of their clients, focusing on delivering a good product for all of them was the only way to treat customers fairly.
Some simply felt success would come as long as they focused on performance, and a few felt the level of transparency required to offer co-investment or customisation could be a threat to their ‘edge’ or intellectual property.
Others cited their small size, suggesting partnerships might be more feasible as they grow.