The rate of cash flow to hedge funds of funds is slowing precipitously, with net inflows down nearly 40% in the first six months of this year.
Sources are divided on the reasons, although many say the changing pattern of hedge fund investments by institutions is a big contributor.
While many funds-of-funds managers admitted to slower inflows this year, no one interviewed for this story said the problem was acute.
"It's a digestion issue. Funds of funds had a real big meal to digest in the form of a lot of cash flow in the past couple of years, and they're happy to let that settle," said Phillip N. Maisano, chief executive officer and chairman of EACM Advisors LLC, Norwalk, Conn., a division of Mellon Financial Corp., Pittsburgh. The firm managed $4.7 billion in hedge funds of funds as of June 30.
But the net flow numbers for the first six months suggest a bad case of indigestion.
Data from Hedge Fund Research Inc., Chicago, showed net flows into hedge funds of funds for the first six months of 2005 dropping 36.6% to $12.8 billion, compared to the same time period in 2004 when net inflows were $20.2 billion.
(By contrast, HFR reported that net flows to hedge funds through June 30 were up 29% to $38.3 billion, compared to the same period last year.)
Sources gave a range of reasons for institutions delaying funds-of-funds investments. One big reason, they said, is lackluster performance.
Hedge funds of funds returned 2.68% for the first seven months of the year, as measured by the HFRI Funds of Funds Composite index. That's a whopping 143 basis points behind the returns of hedge funds — 4.11% — as measured by the HFRI Fund Weighted Composite index for the same date.
Said Anita M. Nagler, CEO at Harris Alternatives LLC, Chicago: "The U.S. institutional tax-exempt investor is still in there, still searching for hedge funds of funds, but they are taking more of a wait-and-see attitude — not just about hedge funds, but all asset classes." Her firm manages $7 billion in hedge funds of funds.
Other industry watchers said the slowing flow to hedge funds of funds is simply part of a natural evolution, as investors gain experience and comfort with the asset class and are ready to move on to "Phase II" of hedge fund investment.