Updated with correction.
Top-tier hedge funds-of-funds managers are expanding their relationships with underlying hedge fund managers, morphing into active investors of institutional investor assets from mere allocators of those assets.
To improve returns and their relevance to asset owners, the largest, most institutional hedge funds-of-funds firms have ramped up their efforts to develop proprietary, customized investment vehicles in addition to investing in flagship hedge fund strategies.
That's a recent change for most of these firms, sparked primarily by significant institutional interest in high-performing opportunistic investments that don't fit easily into the traditional, fairly liquid flagship hedge fund template. In order to capitalize on less liquid investment opportunities, hedge funds-of-funds providers had to custom-build suitable vehicles.
“We call it active management. We're using hedge fund strategies in a different way to capture the desired outcome. We ask the underlying manager to manage our investment idea or one that they bring to us outside of their flagship fund vehicles,” said Von Hughes, managing director, Pacific Alternative Asset Management LLC, Irvine, Calif. PAAMCO managed $9.5 billion in hedge funds-of-funds strategies as of April 1.
Other hedge funds-of-funds firms that are pressing their underlying hedge fund managers into running custom strategies for them include A&Q, a subsidiary of UBS Asset Management; Aurora Investment Management LLC; Blackstone Alternative Asset Management; Corbin Capital Partners LP; Grosvenor Capital Management LP; KKR Prisma; Mesirow Advanced Strategies Inc.; Morgan Stanley Alternative Investment Partners; and Permal Group.
The investment strategies that hedge fund firms are running for these funds-of-funds managers are extremely diverse, including co-investment opportunities, single-security investments, highly concentrated portfolios, thematic strategies and portfolios of illiquid securities that often feature a lockup period more typical of private equity funds than hedge funds.
Managers said they use these proprietary investments in their own flagship hedge funds of funds, in portfolios of hedge fund managers customized to meet clients' specific needs and sometimes as stand-alone, single-strategy investment funds.