Hedge fund managers are warming up to custom funds

The hedge fund industry is in transition as managers work to provide asset owners with exactly what they want: customization.

Increasingly, hedge fund managers are acceding to demand from pension funds, endowments, foundations, hedge funds of funds and other allocators for custom versions of flagship hedge fund strategies that better meet their investment goals.

Assets managed in separately managed customized hedge fund accounts have skyrocketed over the past five years, sources said.

HedgeMark International LLC, New York, the industry's largest hedge fund managed account provider, for example, has seen huge growth in assets in separately managed hedge fund accounts on its investment platform, said Andrew S. Lapkin, CEO.

Assets run in separately managed hedge fund accounts of all kinds on the HedgeMark platform rose 450% to $22 billion as of Oct. 31 from less than $4 billion when the firm was acquired in 2014 by Bank of New York Mellon Corp.

The proportion of customized hedge fund managed accounts on HedgeMark's investment platform is growing, Mr. Lapkin said. In 2019, 30% of new hedge fund accounts were for co-investment or other highly customized strategies compared with 15% per year between 2015 and 2018.

"Customized strategies are well-suited for dedicated management accounts. We are seeing a continued increase in (hedge fund) manager interest to offer a (dedicated managed account) to large investors," Mr. Lapkin said.

Among myriad possibilities, sources said popular customized approaches within dedicated managed accounts investors' control include managing a single element of a flagship portfolio, concentrating assets in selected co-investments, increasing the volatility of a strategy or applying leverage to boost returns.

Among the many hedge fund managers offering customized strategies to institutions are Abbey Capital Ltd.; Algert Global LLC; Bridgewater Associates LP; Chatham Asset Management LLC; Graham Capital Management LP; Marshall Wace LLP; and Napier Park Global Capital LP.

Hedge fund managers report a surge in demand from asset owners.

Managed futures specialist Abbey Capital, Dublin, for example, is seeing "increasing demand for customized solutions from institutional investors globally," said CEO Michael "Mick" Swift in an email. Abbey Capital is getting requests from asset owners for trend-following and non-trend-following strategies, he said.

Nearly one-quarter, or $3.5 billion, of the $15 billion in hedge fund assets managed by Graham Capital Management are customized, said James M. Medeiros, CEO of the Rowayton, Conn.-based firm.

Mr. Medeiros said given the high level of demand from asset owners for customized versions of Graham Capital's discretionary and quantitative macro and systematic trend-following strategies, it's become clear that "it's no longer a one-size-fits-all world. If you can do customization, you almost have to."

Most of the investors requesting highly customized versions of Graham Capital's flagship strategies are large institutions intent on making minimum investments of $100 million and more typically, between $200 million and $500 million or more to invest.

Fees also are a consideration for investors, Mr. Medeiros said.

"While investors who make larger allocations often are seeking fee concessions, the reality is that it's more expensive for the manager to run a customized strategy," Mr. Mederios said.

Mr. Medeiros declined to comment on Graham's fees.

Other hedge fund managers are following in Graham Capital's footsteps, sources said.

"There been a sea change in the last two years. We are seeing greater flexibility across almost all hedge fund strategies to customize products to meet client needs," said Joseph M. Marenda, a San Francisco-based managing director and hedge fund specialist in the pension practice of consultant Cambridge Associates LLC, in an email.

"Hedge funds are trying to find new ways to increase their relevance to institutional investors, and customization is one of the keys to that effort. By doing so, they are becoming better partners," Mr. Marenda said.

By way of example, Mr. Marenda said he worked with an event-driven hedge fund to create two customized co-investment funds based on "a couple of their top ideas" that he and a Cambridge client found "attractive ... enough to ask if we could establish a separate vehicle for each idea."

The hedge fund manager said yes, resulting in "a win-win for the hedge fund and my client. (The manager has more assets) and a bigger say in the outcomes of these (strategies), and in effect, we built a custom portfolio for … the client," Mr. Marenda said.

He declined to name the hedge fund manager or the institutional investor.

Hedge funds-of-funds managers also are delving deeper into the customization at both the portfolio level as well as using customized hedge fund strategies as the underlying components of the portfolio.

"Custom is in. Everyone wants it. The concept of customization is intriguing and has cache," said William J. Ferri, the New York-based head of Americas asset management and head of multimanager solutions for UBS Asset Management.

Older commingled hedge funds-of-funds portfolios are shrinking and getting "harder to sell," Mr. Ferri said. UBS Asset Management has $41 billion in hedge fund-oriented strategies.

Corbin Capital Partners LP, New York, still has significant assets managed in its commingled hedge fund-of-funds family, but $3.2 billion of total assets of $7.5 billion are managed in customized portfolios, said Gwen M. Gold, partner and director of marketing and client relations.

Corbin's investment teams work very closely with hedge fund managers and have created customized strategies used in building both commingled funds and separately managed portfolios for individual asset owners, Ms. Gold said.

Some customized strategies created by Corbin's investment teams feature one or more co-investments while others combine less liquid investments to create a longer-duration hedge fund-private equity hybrid vehicle. Other custom approaches are strategy specific and concentrate investments in relative value, event-driven and other hedge fund asset classes.

Man Group PLC, London, has taken customization to a higher level than other hedge funds-of-funds specialists.

About 85% of the firm's hedge funds-of-funds offerings from Man FRM now are customized, said Michael D. Turner, CEO of Man FRM.

"There has been a dramatic increase in customization for more tailored approaches over the years," Mr. Turner said, noting "you can have your strategy in any color you like, with internally or externally managed hedge funds. It's rare to see anything `plain vanilla' cross our plate. Many investors come to us and ask for assistance in combining hedge fund strategies into a multistrategy portfolio."

Man FRM manages $14.4 billion in multimanager strategies.

Industry sources expect even more hedge fund managers to customize their strategies going forward.

In the Ernst & Young Global Ltd. 2019 Global Alternative Fund Survey report, researchers said asset owner demand for investing in hedge funds through separately managed accounts and funds of one is "a trend that started this decade which shows no signs of slowing into the future."

Of the 113 hedge fund managers surveyed between July and September for the EY report, more than 60%, including more than 75% of those firms with assets of more than $10 billion, offer separately managed accounts now.

Over the next two years, 39% of hedge fund managers surveyed said they expect the use of separately managed accounts by investors will increase, and 37% said they believe more investors will use funds of one and single-investor funds.