There's a good, old-fashioned tug-of-war brewing between pure consulting firms that are building their alternatives consulting practices and hybrid hedge fund advisory firms that offer advice and their own funds of funds. They're both gearing up to compete for the growing pot of pension fund money heading into hedge funds.
Each camp has something different to offer, and for now they appear to be targeting separate groups of pension funds. But that might not last long. If, as predicted, more pension funds begin allocating money to hedge funds, the competition for that business should grow more fierce.
For the most part, the pure consultants like Callan Associates Inc., San Francisco, and Summit Strategies Group Inc., St. Louis, are catering to medium and smaller pension funds that don't have the resources to investigate hedge funds on their own. There are exceptions, such as Cambridge Associates LLC, Boston, which has a long track record of advising foundations and endowments on alternative investments, and increasingly is bringing that knowledge to pension funds of all sizes.
The hybrid firms, like Blackstone Alternative Asset Management, New York, and Tremont Advisers Inc., Rye, N.Y., generally are making plays for bigger pension funds that have a working knowledge of hedge funds and want more of a say in which managers get their money.
At first blush, Summit Strategies President Steve Holmes doesn't sound like he wants anything to do with hedge funds. "I honestly believe that hedge funds are the great investment management rip-off tool of the early 21st century," Mr. Holmes said.
His problems with hedge funds stem from his belief that the goal for many people in the business is to fatten their own wallets, and it's merely a convenience that their investors make money at the same time. At Summit, Mr. Holmes and his staff emphasize caution.
"We have clients who have placed money in hedge funds, and clients who are thinking about placing money in hedge funds," Mr. Holmes said. "Our advice to them is to put on the oven mitts; this stuff is hot. I can make a case for hedge funds being beneficial to a portfolio, but they scare the hell out of me."
What Summit and other pure consultants offer is advice that is free of any ties to funds of hedge funds offered by the company. With no pressure to make sales, consultants theoretically are free to advise a client to steer clear of hedge funds if that's what they think is in the client's best interest. Other hybrid advisers with investment products might not offer frank advice like that.
"Can they realistically come in and say `this thing (hedge funds) is overblown, we're in the middle of a bubble'? I don't think they have that luxury," Mr. Holmes said. "Based on who they are and what they do, they always have to be bullish."
Mr. Holmes concedes the hybrid advisers' superior ability to pick a specific fund of funds for a client that is ready to invest in hedge funds. He doesn't see that as being Summit Strategies' role, however. His job is to provide his clients with a hedge fund reality check.
No vested interest
Jim McKee, vice president for capital markets research at Callan Associates, sees his firm's mission in similar terms.
"We're not necessarily strong advocates of a particular alternatives strategy," Mr. McKee said. "We're just proponents of getting clients to look at an opportunity and then decide yes or no. We have no vested interest in either decision."
Only in the last year or so has Callan Associates really begun to ramp up its alternatives consulting business. Mr. McKee said the firm's move into alternatives largely has been client-driven.
Mr. McKee is the lone full-time hedge fund specialist among 150 employees. And Mr. McKee doesn't bother researching individual managers. He looks only at funds of funds, which many consultants see as the safest, most effective way for their clients to invest in hedge funds. Spreading assets among several managers diversifies the portfolio and reduces risk. Callan further narrows the field by focusing on funds of funds with $50 million or more under management and at least five years' experience.
"There are probably 500 fund of funds out there at the end of the day," Mr. McKee said. "Size and experience limits it to 50 or so, and the number falls to 25 when you're talking about $300 million to $500 million in assets under management. For one person to actively follow that kind of peer group is easier than following 6,000 individual hedge funds."
Callan sticks to examining funds of hedge funds the same way it researches investment managers. The goal is to determine where the added value is coming from, Mr. McKee said. Was the fund of funds successful because of the manager selection? Because the portfolio had a bias toward a hot strategy like convertible arbitrage?
"I think as long as we're not involved in any kind of investing, we've got a great opportunity to examine where the value added is provided by each of the funds of funds," Mr. McKee said.
No big roles yet
Still, consultants are not yet playing a big role in directing pension fund assets into hedge funds. Mr. McKee said he has heard that only one in 10 hedge fund hirings involve a consultant. A survey by New York-based Deutsche Bank Alex. Brown Inc. of 168 institutional investors invested in or considering hedge funds showed only 7% used a consultant to find a hedge fund investment. Some 23% followed word-of-mouth advice, 17% used prime brokers and 16% gathered their own information.
John D. Dyment, head of the capital introduction group at Deutsche Bank Securities Inc., New York, said when it comes to recommending managers, consultants "do not have access to the information we have access to, for the most part."
The consultant role is to help clients determine risk profiles, investment objectives and asset allocation mixes, and how hedge funds may fit into all that, he said.
As such, consultants are poised to play a bigger role in the future.
Michael J. Mahoney, managing director and senior portfolio manager at EGM Capital, a San Francisco-based hedge fund, and a trustee for the $233 million endowment at Whitman College, Walla Walla, Wash., agreed that consultants serve a vital role when it comes to helping institutional investors with less alternatives experience get into hedge funds. Whitman, he said, recently hired Denver-based consultant Monticello Associates Inc. to replace its longtime consultant Wurts & Associates Inc., Seattle. The sole reason for the switch, Mr. Mahoney said, was that Monticello had more experience with alternatives.
Others think pension funds ultimately will decide to use consultants more because of concerns over fiduciary responsibility.
Charles Gradante, managing principal at the Hennessee Group LLC, a New York-based hedge fund adviser, said for pension funds to use a fund of hedge funds as an investment vehicle conflicts with the pension funds' fiduciary responsibility.
"They wouldn't use a fund of traditional managers," Mr. Gradante said. "They use consultants and have direct transparency."
Mr. Gradante said more often than not, a pension fund is not the largest investor in a fund of hedge funds. Consequently, the pension fund's assets are run "at the behest of the fund of funds, which is a conflict with what's going on, on the traditional side."
He said this amounts to abdicating fiduciary responsibility. "You can delegate, but you can't abdicate."