Who'd be a HFOF Manager?

Back in May, I reported on our efforts to find a suitable hedge fund-of-funds manager or managers for potential inclusion in some of our clients' portfolios. The short list of managers making it through our initial screening process were very receptive to a face-to-face meeting and generally did not hesitate to field their key staff to answer our questions. (I'm always jealous of investment firms who are able to employ clearly talented staff just to answer the questions of people like me and to produce very impressive RFP documents!) I can't help musing how receptive such firms might have been had we asked for the same level of response and attention prior to the global banking crisis! Although it's difficult to generalise about such a diverse corner of the investment world, the objectives of hedge fund-of-funds tend to be defined in terms of target annual return  (LIBOR + X% pa) and expected annual volatility (Y% pa). There's no doubt, as far as we can tell, that the global banking crisis led to some unexpected results, in terms of delivered returns, with monthly losses typically exceeding previously modelled expectations. This seems to suggest that the idea of expecting a small month-on-month positive return from these investment vehicles, delivered in all market conditions, can now be discounted. However, that's not to say that they can't be expected to produce a reasonable risk-return trade off in future. To my mind, a serious threat to many traditional hedge fund-of-funds managers is emerging from forms of more highly regulated investment vehicles, which are structured in such a way as to conform to European UCITS regulations (implying greater investor protection than the unregulated offshore world can promise). This approach should offer much more comfort to investors who are more used to the regulated fund environment. To be fair, there is already a general move by hedge fund managers to produce UCITS versions of existing funds and strategies. Detractors claim that this will restrict unduly the manner in which such funds can be managed and therefore undermine the optimal risk-return trade off. It's probably too early to know. So where are we up to in our search for a suitable vehicle? Well, we've alighted on an Exchange Traded Fund (ETF) which seeks to track a basket of underlying hedge fund strategies, where the underlying assets are held in individual managed accounts with a large independent custodian and the funds are priced daily. The returns, net of all fees, appear to be at least as good as those generated by the best of the traditional hedge fund-of-funds world and the 'operational risk' to which our clients would be exposed are, in our view, much reduced. We're still looking for the catch! Apart from that, we note the increasing prominence of single manager, multi-strategy funds, which we plan to investigate further - just as soon as the investment world returns from it August break! John

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