Hedge fund managers are becoming trusted advisers to their clients, adding the role of portfolio consultant to their investment duties for large and small investors.
Institutional investors the world over are looking to the hedge fund industry for assistance in managing their entire portfolio, sources said.
That assistance very often comes in the form of investors requesting — and receiving — their hedge fund managers' macro views of where global markets are headed, how individual asset classes or strategies are likely to react to changing scenarios, and how portfolio weightings should be shifted in response.
The delivery mechanisms hedge fund managers use for sharing their world view with their institutional clients range from commoditized, modular approaches to intensely customized strategic partnerships that seat the manager at the portfolio decision-making table with internal investment staff and external investment consultants.
“Institutional investors desperately want knowledge transfer for the purpose of improving the asset allocation and returns of their whole portfolio. Hedge fund managers are increasingly being tapped as risk consultants, filling an information gap that their regular consultants may not be able to,” said Daniel Celeghin, partner, Casey Quirk & Associates LLC, Darien, Conn., a management consulting firm serving investment companies.
“It is becoming essential: If a hedge fund manager has intellectual capital, you need to share it with clients,” said David G. Kabiller, managing and co-founding partner, AQR Capital Management LLC, Greenwich, Conn. AQR managed $22.7 billion in hedge fund assets as of June 30.
Some institutional investors have gone so far as to ask their hedge fund managers for assistance with total portfolio rehabs.
Bridgewater Associates LP, Westport, Conn., has been strategically engaged with its institutional clients since the company opened in 1975, advising them about how to build risk-managed portfolios. But clients are requesting even more, said Robert Prince, co-chief investment officer, in an e-mail.
“The bigger sea change is in how clients are using us. The emphasis has shifted to "Pretend I have a white sheet of paper, how should I run my fund?' types of questions,” Mr. Prince said.
“There is a greater openness and desire to move in more radical directions than we have seen in many years. As part of this, we are seeing a new level of engagement between the investment staff and the board about what the goal of the fund should be and what the benchmark of the fund should be (e.g. an absolute-return benchmark vs. an asset-mix benchmark),” he added.
Bridgewater managed $75.3 billion as of June 30 in its Pure Alpha hedge fund strategy, which Mr. Prince said is closed to new investment.
The global money management industry has received the message loud and clear that institutional investors expect more value-added research services — without necessarily paying for them — from their money managers, sources said (Pensions & Investments, Aug. 20).
Hedge fund managers also received that message but so far, just a small number of players have had the forethought to build efficient client service infrastructures robust enough to deliver knowledge and partnership to institutional investors at a reasonable price for the money manager, Mr. Celeghin said.
Bridgewater and AQR are leaders within the small group of hedge fund managers with long-standing, well-developed client service teams, but it took the financial crisis in 2008 to drive the rest of the hedge fund industry to become responsive to institutional investor demands. Many firms even now are grappling with how best to deliver their intellectual capital.
“After the financial crisis, investors saw that even the most brilliant hedge fund managers could perform poorly. It was clear that many did not have a clear enough understanding of many of the hedge fund strategies they were invested in pre-crisis,” said Goran Hagegard, managing director at money management industry researcher Greenwich Associates LLC, Stamford, Conn.
“The needs of institutional investors have changed. They need to know what's behind the investment strategy. Not just performance, not just the people managing the strategy, but also what the manager's fundamental view is on how markets misprice securities and how the manager will profit from utilizing that knowledge,” Mr. Hagegard said.
The New Jersey Division of Investment, Trenton, is among institutional investors seeking more information and collaboration from its hedge fund managers. In August, the division extended its relationship with Och-Ziff Capital Management Group LLC, more than doubling the firm's total assignment to about $1.9 billion (P&I, Aug. 20).
While fees were an important factor in the change, the New Jersey division's deeper relationship with Och-Ziff will “increase the information sharing with the manager, thus enhancing staff's ability to make informed investment decisions when implementing the overall allocation plan,” said Timothy M. Walsh, director of the New Jersey division and chief investment officer of the $69.9 billion New Jersey state pension system, in an Aug. 2 memo to the State Investment Council.
Consultants generally are supportive of strategic partnerships between their investment clients and money managers, provided a manager has the necessary skill set to deliver on its promises.
“It's important to assess a manager's asset allocation expertise, risk management capabilities, the breadth of the asset-class offerings and whether it has ability to offer a truly customized approach,” said Erik L. Knutzen, chief investment officer of NEPC LLC, Cambridge, Mass.
Mr. Knutzen stressed the importance of setting mutual expectations for the partnership ahead of time and making sure that governance by the institution's staff is careful and constant. The most successful strategic working relationships are “not overly broad. The manager shouldn't be able to do absolutely anything he or she wants. The investment parameters need to be more narrow for these arrangements to work well,” he added.
“Sharing the breadth of our knowledge is a natural outgrowth of what we do,” a process Och-Ziff has been developing over the past seven years, said Daniel S. Och, chairman, CEO and senior managing director.
Investors in Och-Ziff's hedge funds benefited in 2010 and 2011 when the firm's investment teams warned that it was “too early to invest in European dislocations. Between 2005 and 2007, we told clients that we were worried about the credit markets and recommended that credit exposure be reduced. This was eye-opening for many clients because it was clear that Och-Ziff wasn't trying to sell them something,” Mr. Och said.
Client-facing investment strategy specialists are sharing with clients the firm's now more bullish recommendations about European investment opportunities, as well about the credit side of commercial real estate.
Och-Ziff managed $29.9 billion in hedge funds as of June 30.
London-based credit specialist hedge fund manager CQS (UK) LLP, has “perspective on relative value approaches across all CQS strategies” and consequently is regularly tapped by clients for advice on how to manage problematic pools of assets, said Peter Warren, portfolio manager of the CQS Diversified Fund.
“We provide a jungle guide to structured credit and asset-backed securities, two of our areas of expertise. We start by advising on our existing portfolios and once we successfully manage or advise clients how to wind down these pools, they often ask, "How can I use your expertise to solve X problem?' Investors realize that there are a lot of skills within the hedge fund community that could be of help to them,” Mr. Warren said.
Mr. Warren said he tends to be the “front line” CQS employee in conversations that have increasingly sought broader consultation about the investor's overall portfolio “along the lines of "how can you inoculate my portfolio against interest rate exposure? Can you manage away my credit risk?'”
CQS does not have a dedicated investment solutions client service team. Mr. Warren said by necessity, he has to employ a “cast-iron process for devising solutions as well as an ability to judge what it is that the client needs and what they expect.”
CQS managed $11.3 billion as of June 30.
This article originally appeared in the September 17, 2012 print issue as, "Investors turn to managers for strategy, macro advice".