Since the emergence of “Modern Portfolio Theory” and the “Capital Asset Pricing Model” in the late 1960s, institutional investors have taken a quantitatively driven approach to portfolio construction, looking to create portfolio diversification and obtain better risk-adjusted returns by balancing their asset-class exposures. This journey has seen several important advancements in thinking about how to optimally achieve desired results.
Funds that want to take the total portfolio approach first need to get the total portfolio view. To do that they not only need data – and lots of it – but a rock-solid understanding of exactly how they’re going to use it.
‘1940 Act’ hedge funds getting a toe hold in Australia
(Pictured: Fred Ingham)
The global hedge fund industry, which has over the past few years reduced its reliance on the high net worth market by appealing more to institutional investors, looks like going through another transformation as funds gain new exposure to the advised retail sector.
In Australia, global manager Neuberger Berman (NB) has developed an advisory relationship with the retail-orientated Select Asset Management in relation to Select’s alternatives offering in the retail market. Like other big hedge funds of funds (FoFs) managers, NB had already developed an advisory and custom account capability distinct from its hedge fund pooled product offering. NB also has single-manager funds and a range of other unlisted alternatives capabilities. Its alternatives assets under management total US$19 billion.
The Select arrangement has now been in place for about six months. According to Fred Ingham, NB’s London-based head of international hedge funds, the relationship is a “symbiotic” one, with research sharing around the alternatives sector.
The growth of regulated alternatives products, such as the 1940 Act funds in the US and UCITS in Europe has produced a new range of alternatives funds around the world which can now satisfy the typical requirements of liquidity and governance for the advised retail market.
As its name implies, the 1940 Act has been around for a long time. It’s the Act governing mutual funds and closed-end funds offered to the general public in the US. What’s new is that alternative asset managers are now putting the effort into making at least some of their funds comply with the Act, enabling them to gather assets from a new market. And the demand, following dissatisfaction with long-only equities and bonds, is also a bit new.
Fred Ingham says that NB was early into 1940 Act-complying alternatives market in the US and this section of the market is one of the fastest growing in the world. For a big manager like NB, it helps that the market has high barriers to entry.
“The general thesis is that the weighting to alternatives (from the US retail market) will rise substantially,” he says. “You have to offer daily pricing and daily dealing (applications and redemptions). It’s difficult to charge incentive-based fees. You need a big team. The terms may look a bit like a traditional manager’s products. But there’s been a proliferation … They’re liquid, transparent, have good corporate governance and are cheap. Suddenly people are thinking about them as they do more traditional asset class funds.”
Lucas Rooney, joint head of NB in Australia, says that one of the drivers of a swing back to alternatives generally is the question over the direction of the two big traditional asset classes, equities and bonds.
“We haven’t seen a lot of money actually moving yet but there’s certainly been a heightening of interest,” he says.
Another big driver is that active managers in most asset classes are having a better time of it this year than they did in 2011 and 2012. Big consulting firms, including Russell Investments at its 2013 conference in Sydney, have predicted that the run in beta is over for a while and clients should renew their search for alpha in the current cycle.
Ingham says: “This is a good environment for hedge funds. They’ve performed well this year as correlations within the market have come down.”
An issue for the industry though, is that some of the institutional quality managers which appear best able to fit the trends in the market, will invariably be bigger and more established. The evidence, from NB and other FoF managers, is that smaller and newer hedge managers often outperform.
“We did an exercise where we looked at all the hedge fund investments we’d made over 10 years and we found that there was meaningful outperformance by the smaller and new managers,” he says. “This makes sense of course.”
It also means that’s there’s still lots of work to be done for hedge FoFs in evolving their own products and providing advice to the likes of Australia’s Select.
