Bigger firms are riding in

Institutions are moving in quickly on the hedge fund territory dominated by boutique-sized operations.

The hedge fund world has changed enormously over the last few years. Not just the size but also the profile of the industry has changed. Potentially the most significant evolution has been the entry of institutions into the asset class – on both buy and sell sides. But while this is in many ways a huge opportunity, it also provides a number of challenges. The boutique model evolved for a reason. Many talented money managers felt constrained by the culture of big institutions, with their often unwieldy administration and management. The big asset managers, for their part, were generally happy to leave this little understood and risky sounding area to the specialists. The more innovative fund management houses were stirred by both the number of talented managers slipping through their grasp as they left to set up hedge funds, and by the hefty fees these individuals were able to command as successful hedge fund managers. Institutions, however, faced the challenge of trying to allow managers the freedom and autonomy to foster a successful, entrepreneurial culture, while adding their natural advantages of scale and administrative back-up. Also, they had to address the traditional problem of not creating a culture of envy, in which “ordinary” fund managers felt hard done by next to their better-paid hedge fund colleagues. Most fund managers are keen to get a piece of this hedge fund business, but in reality few have actually managed to build operations of any real scale. In the US, for example, institutions still cannot compete with the boutiques in terms of total asset size. US hedge funds manage an estimate of between $500bn (E435bn) and $600bn. Of this, only around $31bn is run by institutions. Additionally, in Europe, only a relatively small proportion of assets are managed. Threadneedle, Henderson, Deutsche, Jupiter and Gartmore are among the few asset managers that have set up businesses that register on a global scale. On the buy side, serious institutional interest in hedge fund investing is only just starting to make its presence felt, spearheaded by the US. Turbulent equity markets have seen the values of pension funds falling, fuelling interest in alternative investment strategies. In Europe, there has also been a wave of investment, with giant Dutch plans ABP and MN Services leading the way.

Route opens up

The route that institutions are taking has opened up a new area for asset managers. Pension funds’ entry point into the hedge fund world is generally via a fund of funds, which provides them with contacts, due diligence and diversification. As a result, companies have been quick to move into this area, either by building operations themselves, or, more commonly, by buying in or forging alliances with existing operations, which gives them an all-important track record. Recent deals include Man with Glenwood and RMF, Oppenheimer and Tremont and Gartmore with Riverview. Again, there are a number of challenges involved in incorporating these units successfully into an institutional culture, in terms of allowing them the autonomy they need while providing the correct backup and infrastructure. However, this growing institutionalisation is often cited as producing a number of demands on the industry. One of the biggest bones of contention is transparency. Because of their risk averse stance, institutions often require a high level of reporting from their underlying managers, and there have been fears that this could involve demands for the disclosure of total portfolios and position sizes. However, this does not seem to be the case in practice, and indeed would be unlikely to help with any realistic risk assessment. In any case, the institutional hedge fund manager should be at an advantage here, having the administrative expertise and back-up to provide regular and thorough reporting.

Glut concerns

One of the concerns often raised about institutional investment in hedge funds is size. In a capacity constrained industry there have been fears that institutions could provide a glut of money. Against this, despite a number of shutdowns in the recent market volatility, hedge funds are experiencing robust year on year growth, with a number of new and talented managers coming on stream. Managers that can meet the operational and cultural challenges of this demanding industry should be able to bring to bear their natural advantages of scale and reliability. Those that succeed are likely to reap sizeable benefits from hedge funds.

Stephen Attenborough is head of European sales, fund of hedge funds, at Gartmore in London

‘Most fund managers are keen to get a piece of this hedge fund business’

Stephen Attenborough, Gartmore