influential fund of fund managers dictating the way hedge fund portfolios are investing
Fund of fund managers are becoming increasingly influential in the way hedge fund managers run their portfolios, according to David Smith, chief investment director at multi-manager group GAM.
In an address to delegates at the recent Alternative Investment Summit in London, Smith said the increasing rise of funds of hedge funds and the dominance of a few top players in that arena could lead hedge funds to take on more risk to generate returns for fund of funds investors.
There are around 600 funds of hedge funds managed by around 200 companies and the market has seen massive growth in recent years.
The top 10 providers dominate the $152bn in assets under management in the industry, and capital inflows to single strategy hedge funds have come mainly from funds of funds in recent months.
Smith said this concentration of funds under management means a few fund of funds operators will be able to engineer changes within the wider hedge fund market.
Their needs will dictate the direction of the single strategy hedge fund market and could lead to funds taking more risk and becoming increasingly volatile in order to meet the needs of funds of hedge funds, he said.
In addition, demand for multi-strategy portfolios could fall, competition between single strategy funds could increase, leading to a shorter lifespan for poorer managers and the cyclical fashion of hedge fund strategies could become more pronounced, he said.
Competition among hedge funds could exacerbate a dangerous situation that already exists where managers are promising unlikely high returns in order to attract assets under management.
Smith said the next crisis in the hedge fund industry would not be caused by fraud but by the disappointment of investors, which in turn could affect investment in the asset class.
'We have seen more ridiculous promises of rates of return in the last five years than ever before from managers desperate for assets under management,' he said.
Over-optimistic promises are not confined to single strategy funds alone, he added, with many fund of hedge fund groups also desperate to grow.
He warned that hedge fund analysis is short sighted, rarely looking beyond the last 10 years, despite the fact hedge funds have been in existence since 1949.
'If you look at 1960s, 1970s, 1980s and 1990s returns you will see huge divergence,' he said.
According to Smith, hedge fund returns in the 1960s were mixed: in the 1970s they were bad, in the 1980s they improved and in the 1990s they were exceptional.
'It is an incomplete sample of the universe to look only at the 1990s,' he said.
Every hedge fund manager will talk about good performance but how they are preparing for the next five years is more important, he added.
Partner Insight: For Blackfinch, the arrival of its IHT portfolio services was a 'natural evolution' in the group's offering and points to an established track record of returning cash to investors.
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