SAN FRANCISCO — As might be expected from a man who wrote a seminal white paper in 2005 titled “Adapt or Die Trying: Darwinism and Intelligent Design in the Hedge Fund Industry,” Donald H. Putnam has a contrarian view of the future of the hedge fund-of-funds industry.
Mr. Putnam is managing partner in the San Francisco office of Grail Partners LLC, a merchant bank he founded in 2005.
While others interviewed had a generally rosy opinion of the success likely to come to the largest and most institutional of hedge fund-of-funds managers, Mr. Putnam said he is convinced that institutional investors will migrate during the next five years to invest directly in very high-quality multistrategy hedge funds and will do so at a faster pace than they did in the past.
“Pension funds want hedge fund returns, and hedge funds of funds are their training wheels. But in periods like the current market dislocation, high-quality multistrategy hedge funds with strong investment teams in a variety of strategy areas will do better, if only because their fees are lower,” Mr. Putnam said.
Mr. Putnam did agree with the others interviewed that pension funds likely will begin to invest more in specialty, niche-focused hedge funds of funds. But he said pension funds would pair those with multistrategy funds, rather than the generalist funds of funds that other industry observers said would comprise the core of their hedge fund portfolios.
Because the learning curve on hedge funds is shortening, Mr. Putnam said, “The training wheels are coming off sooner for pension funds.” He noted the average tenure of a hedge fund-of-funds manager assignment is down to three to four years now from five to six years just a few years ago. Mr. Putnam predicted the tenure of hedge fund-of-funds managers likely will drop to between one and two years very soon as pension fund investment staff absorb more of what they need to know from their multimanager mentors.
Mr. Putnam also pointed to a couple of new firms — particularly Makena Capital Management LLC, Menlo Park, Calif., and Hall Capital Partners LLC, San Francisco — with a new business model for hedge funds of funds that likely will take a fair amount of business from more established managers. These firms, he said, have eschewed the standard, fixed-fee model of a 1% management fee and 10% performance fee. Instead, Makena, for example, charges a management fee between 35 and 50 basis points and a 5% fee for performance of more than 10%. Because Makena only offers one large commingled hedge fund of funds and not customized separate accounts, the model is extremely scalable.
“I think institutional investors will be attracted by very high quality fund-of-funds managers with excellent performance like this that offer more reasonable pricing,” Mr. Putnam said.
In his last salvo across the bow of conventional thinking, Mr. Putnam predicted a trend that he thinks will eventually displace hedge fund of funds for many smaller or more conservative institutions: More investment by smaller and more conservative investors in hedge funds with guaranteed principal features and structured notes that have been thus far more popular with high-net-worth investors.
