Hedge fund managers are the third-biggest institutional users of exchange-traded funds and exchange-traded products, but they're reluctant to talk about it.
That's because pension fund, endowment and foundation clients won't be happy if the hedge fund managers they are hiring for their exceptional investment skills and for which they are paying high fees — 2% for management and 20% for performance — are relying too much on lower-cost index-based products like ETFs and ETPs.
“Investors in hedge funds are paying big fees for active management equity selection. If a long/short manager goes long individual equities and only shorts ETFs and (indexes), it is a terrible deal for investors (because) fees should be a lot lower,” Jim Vos, CEO, head of research and principal at hedge fund consultant Aksia LLC, New York, said in an e-mail.
“Single-stock shorting is quite difficult. That's why hedge fund managers get the big fees,” Mr. Vos stressed.
Said Daniel Gamba, managing director and head of the America iShares institutional business at BlackRock Inc., New York: “There is a stigma to using ETFs for many hedge fund managers.” BlackRock is the industry's largest ETF provider, with $483.5 billion as of Jan. 31, according to data from The ETF Industry Association, Philadelphia.
“Hedge fund managers who don't use ETFs say they don't because they are paid to pick securities. Others that do use them have trouble telling clients they use ETFs, but on the other hand, have no trouble telling them about the complicated futures, options and other derivatives they also use as investment tools,” noted Mr. Gamba.
Many industry sources agreed with Stephen L. Nesbitt, who said in an e-mail: “ETFs are ubiquitous in hedge fund portfolios, (used) mostly as hedging instruments.” Mr. Nesbitt is CEO of alternative investment consultant Cliffwater LLC, Marina del Rey, Calif.
A number of large well-known hedge fund managers are active ETF users, according to their Dec. 31 13-F filings with the Securities and Exchange Commission. They include Bridgewater Associates LP, Eton Park Capital Management LP, Lone Pine Capital LLC, Millennium Management LLC, Oak Hill Investment Management LP and Paulson & Co. Inc.
State Street Global Advisors' SPDR Gold Shares, which totaled $63.5 billion as of Dec. 31, is one of the hedge fund industry's most popular ETFs, with 145 hedge funds invested in it as of that date, according to 13-F filings.
Paulson & Co. was the largest hedge fund holder of SPDR Gold as of Dec. 31 with 17.3 million shares, down about 3 million shares from Sept. 30, according to the firm's 13-F filing.
While ETF use might be widespread among hedge funds, the dollars invested using these instruments as of Dec. 31 were fairly small — an estimated gross $76 billion — compared to the about $1 trillion hedge fund managers owned of single-stock holdings, according to Goldman Sachs & Co.'s analysis of 13-F and short interest filings.
In aggregate, about 17% of hedge fund short positions and 4% of long positions were made through ETFs, estimated Goldman Sachs researchers from the company's global economics, commodities and strategy research unit. The data is from the company's Feb. 21 edition of “Hedge Fund Trend Monitor” report.
The growth of hedge fund investment in SPDR Gold and other ETFs is indicative of changes in the way that these active managers have used ETFs as portfolio management tools over the years, said Kevin Quigg, global head of SPDR ETF strategy and consulting at State Street Global Advisors, Boston.
SSgA is the industry's second largest ETF provider, with $287.6 billion as of Jan. 31, according to The ETF Industry Association.