Time to Refresh Their Perspective
BOSTON, MA–(Marketwired ) – During a bull market, investors may naturally yearn for less-hedged exposure — and in turn underestimate the positive long-term impact that hedge fund allocations can provide via differentiated returns, capital protection and reduced volatility.
At the same time, careful hedge fund manager selection is more important than ever –given the evolution of the hedge fund industry, explosion in number of funds and visibility of some larger funds with lackluster performance. Every allocation should involve a granular assessment of each hedge fund’s value proposition as reflected in its investment philosophy, terms, fees and business operations, according to “Hedge Funds: Value Proposition, Fees and Future,” a new report from Cambridge Associates, the global investment advisor.
“To a certain degree, the concept of alpha has been lost in a recent market environment of higher correlations across assets and narrower return dispersion across managers. But we believe that over time the institutional investors that do best embrace active management and understand that partnering with talented hedge fund professional adds value to diversified portfolios,” said report coauthor Jon Hansen, Managing Director at Cambridge Associates.
Successful Hedge Fund Investing is a Partnership
“The challenge remains constant and is particularly important today: Identify the right hedge fund partners and pay the right price for alpha,” added Gordon Barnes, Manager of Business Risk Management at Cambridge Associates . “Our clients’ best hedge fund relationships are with managers that care not just about their risk-adjusted track records, but also are committed to being good business partners.”
The report underscores key concepts and realities that Cambridge Associates believe limited partners — as well as managers — should keep front and center. For instance…
- LPs should look at hedge funds as individual opportunities, not as an overall asset class. Each hedge fund investment should represent a unique line item in a diversified portfolio and should serve a specific role — e.g., growth engine or diversifier. As part of their due diligence, LPs should understand the attributes of each fund and consider how much they are willing to pay for those attributes.
- Be disciplined when it comes to investment psychology. LPs should not allow enthusiasm around macro conditions — especially bull markets — to take the focus off the importance of certain hedge fund strategies. At the same time, LPs must be willing to redeem from managers if the value proposition offered is no longer attractive or if a more compelling value proposition exists elsewhere, either through another hedge fund or within a different asset class altogether.
- Being vigilant about keeping management fees and pass-through expenses reasonable is important for LPs and GPs alike. In general, it’s appropriate for services that benefit the fund, such as administration, audit, insurance, investment research, and legal to be picked up by LPs, but other expenses — ones that could be considered business overhead costs — including base compensation, investment-related legal, marketing, research travel and technology costs should be covered by the GP. Because a manager generates strong returns does not mean LPs should have to pay excessive fees and forgo an extra 25 bps or 50 bps annually.
- Look for efforts to even out the balance between LP and GP interest including fees that scale down as assets grow. The report suggests that managers should consider a structure in which fees go down as assets grow. Management fees are intended to allow the manager to run the business and should not be a primary source of profit. LPs should be proactive in making sure there is a balance between fees versus the cost to run the business.
- Liquidity has real value. LPs should be skeptical of managers that artificially claim the need for a long-term lock-up for more liquid strategies and for portfolios that do not offer an equitable trade-off on the incentive fee. Focus on managers that have a balanced capital base and have a liquidity structure in place that represents a good asset/liability match.
“Hedge funds can add value to diversified portfolios, but not all hedge funds do — not even close. Of the 9,000 or so entities self-titled as hedge funds, only a small percentage — think single digits — offer compelling value propositions for institutional investors. Given the odds, good manager selection is essential,” said Hansen.
For a copy of the report, “Hedge Funds: Value Proposition, Fees and Future,” please contact Frank Lentini, Sommerfield Communications at (212) 255-8386 / Lentini@sommerfield.com.
About Cambridge Associates
Founded in 1973, Cambridge Associates is a provider of investment services to institutional investors and private clients worldwide. Today the firm serves more than 950 global investors and delivers a range of services, including investment consulting, discretionary investment solutions, research and tools (Research Navigatorsm and Benchmark Calculator), and performance monitoring, across asset classes. Cambridge Associates has more than 1,100 employees based in eight global offices in Arlington, VA; Boston; Dallas; Menlo Park, CA; London; Singapore; Sydney; and Beijing. Cambridge Associates consists of five global affiliates that are all under common ownership and control. For more information about Cambridge Associates, please visit www.cambridgeassociates.com.