Consultants changing sides

Client demand and higher fees are luring more investment consultants into money management, particularly hedge funds of funds.

Consulting firms are managing at least $2.3 billion in discretionary alternatives portfolios, mostly focused on hedge funds. The total most likely is much larger, because many consultants do not report their assets under management.

The total in hedge fund-of-funds or diversified alternative strategies would top $8 billion were it not for the spectacular wind-down this year of Russell Investments' $6 billion hedge fund-of-funds offering. Tacoma, Wash.-based Russell now manages just $100 million in hedge fund of funds (Pensions & Investments, July 21 and June 23)

Notable names making their first forays into hedge funds of funds include Angeles Investment Advisors LLC, Evaluation Associates LLC and Clontarf Capital. They've launched or are preparing hedge fund or diversified alternative funds of funds, either as stand-alone strategies or as part of a total portfolio outsourcing.

Consultants' approaches range from non-discretionary portfolio construction advice to managing customized separate account hedge funds of funds to commingled hedge funds of funds.

The success of early movers in the consultant-managed alternative fund-of-funds arena has helped prod others to make the move.

“This is a natural progression into implemented consulting, where the consultant carries the advice into discretionary investment decision-making,” said Michael Rosen, Angeles Investment Advisors' principal and chief investment officer in Santa Monica, Calif. “Some clients like the single point of accountability. And for many clients, outsourcing is a way to lighten their administrative burden. Managing increasingly complicated portfolios, especially in hedge funds and other alternatives, is just taking too much staff time.”

Fees are another motivator.

Hedge fund-of-funds managers typically charge a management fee of 100 basis points on top of the fees charged by the underlying hedge fund managers in the portfolio, generally a 2% management fee and 20% performance fee over an agreed high-water mark. In contrast, specialty alternatives consultants generally charge 20-50 basis points for hedge fund portfolio construction advice and slightly more for discretionary asset management, sources said. The larger the mandate, the lower the fee.

And as the client saves on management fees by using a consultant for hedge fund-of-funds management, the consultant benefits — mightily — from a revenue stream that is earning a much higher fee than the typical four- to eight- basis-point annual fee for a traditional retainer relationship.

Two large, longtime players stand out among consultants in discretionary alternatives money management.

Cambridge Associates LLC, Boston, provides advisory services to clients with $1.6 trillion of assets, including $3.9 billion in discretionary assets, said Deirdre Nectow, director of business development. Although she wouldn't say how much is related to hedge funds, the firm's ADV form filed with the Securities and Exchange Commission shows Cambridge managed $924 million in 11 customized, single-client alternative investment partnerships.

Like Russell Investments, Wilshire Associates Inc. and several other investment consulting firms, New York-based Mercer separates discretionary money management and non-discretionary investment advice into different affiliates.

Mercer Investment Management runs $23 billion in discretionary accounts for its clients, of which more than $400 million is managed in single-strategy hedge funds in customized client portfolios, said Rich Nuzum, worldwide partner and global business leader. Mercer Investment Consulting provides portfolio construction, manager selection and due diligence advice that “can often be very directive,” stopping short of a discretionary investment on $8.5 billion of client assets invested in single-strategy hedge funds, Mr. Nuzum said.

Other consultants now managing hedge funds of funds are Consulting Services Group LLC, Memphis, Tenn., and Hammond Associates Institutional Fund Consultants Inc., St. Louis, according to the limited partnership listings on their ADV forms. Wilshire Funds Management, the discretionary money management arm of Santa Monica, Calif.-based Wilshire Associates also has been managing hedge funds of funds since 2006.

With these funds, investment decision-making resides with the consultant, and the dollars managed are not insignificant: CSG's Liberty Oak Capital Fund LP totals $680 million; Hammond's Access Hedge Fund Investors SPC fund has reached nearly $120 million in its first year, according to each firm's ADV. Wilshire manages $92 million in its hedge fund of funds, according to data provided by Wilshire to P&I.

Angeles already manages about $1 billion in discretionary fund-of-funds separate accounts in all asset classes for about two dozen clients and will be introducing commingled fund versions, including a hedge fund of funds, by the end of the year.

Clients and prospects of Evaluation Associates, Norwalk, Conn., have been so persistent in asking for discretionary management that executives there were pushed into finding a way to provide it, said Bryan Decker, managing director and chief investment strategist. But unlike Angeles, Evaluation Associates will only manage customized separate accounts in all asset classes, Mr. Decker said.

Aoifinn Devitt, principal of London-based Clontarf, said her firm also will only offer discretionary management of alternative investments in separate accounts, while continuing to offer more traditional, advice-only consulting services. “We are transitioning into money management, but will continue to do a lot of research and education. This is by way of easing new clients into money management,” Ms. Devitt said.

Some consulting firms, including Aksia Ltd., Rocaton Investment Advisors LLC and Albourne Partners Ltd., perform manager research and construct a model portfolio for a client, but will not move into discretionary hedge fund-of-funds management.

While specialist hedge fund consultant Aksia has been pushed by clients with unique needs to actively manage about 1% of its $12.7 billion under advisement, there are no plans to increase that business, said Jim Vos, chief executive officer and head of research at the New York-based firm. “Our clients want us to remain a pure-play consultant and to be a wrench in their tool kit. They want us to be doing only one job and that's helping them to build their particular hedge fund portfolio,” Mr. Vos said.

Contact Christine Williamson at [email protected]