Time to rock the boat, go with the flow, or sink?

Fri Mar 6, 2009

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As new strategies are being promoted, many investors are at sea. Susan Barreto reflects on whether buying them will instill calm or rock the endowments, foundations and pensions boat more


By Susan Barreto, deputy editor

The global credit crisis has turned traditional economics on its head. As new strategies are being promoted, many investors are at sea in terms of knowing whether buying them will instill calm or rock the institutional investor boat more.

Despite the gloom, there seem to be plenty of fund launches and additional capacity with experienced blue-chip hedge fund managers. But investors are anxious to see whether or not these new offerings fit their long-term investment strategy - and in many cases are employing asset liability studies to gain a snapshot of their portfolio.

Once the traditional investment consultant has signed off the study and approved hedge funds, many pension funds are starting to turn to specialist groups such as such as Albourne and Aksia before investing serious sums. There seems to be recognition that even though hedge funds are only a small portion of the portfolio, their effect can be mighty when it comes to keeping the boat on an even keel.

Until now, most investors have accepted what they have been given. But now, institutions, mainly in the US, are pondering whether it's time to stand up in the rowing boat and reconsider fees and lock-ups.

What is clear is that the bargain basement mentality is not an appropriate substitute for an investment philosophy. Perhaps counter-intuitively for large investors used to heavy discounts for bulk assets, now is the time to pay for expertise in hedge funds; the kind of expertise that comes with knowing more than just a handful of industry superstars.

Most investors may still demand lower fees and greater liquidity, but looking for these traits alone in a manager can lead a portfolio into uncharted waters. Funds with great liquidity terms suffered the most when the markets tanked. Specialist consultants offer a solid middle ground to investors. It might not be cheap, but it is certainly better than the risk of getting it wrong.

Again, for investors serious about strategic market plays, individual hedge fund holdings chosen by a third-party consultant might smooth some of the waves, while funds of hedge funds still make sense for investors that want access to a broad range of strategies. But if Madoff has taught the institutional investor community anything, determining fiduciary responsibility is also important. At the end of the day, trustees need to abdicate their oversight of the portfolio to experts willing to take responsibility for their own choices.

It seems that investors really wanting to rock the boat are spending long hours in their lawyer's office - but although their intentions are good, they have little to gain from suing their consultant, per the lawsuit filed against NEPC by the Town of Fairfield (see page 11).

In the case of one prominent hedge fund, some investors may have had advanced intelligence of a strategy's demise and put in redemption requests ahead of other investors that may now have to write-off their entire investment. In these cases no one wins, but the outcome of clawback provisions in the case of Bayou and Madoff pit investor against investor thereby capsizing the boat with all on board.

So should investors head for calmer waters and be willing to pay for advice - or be willing to rock the boat in rough seas? The question can only be answered according to the faith investors can put in their due diligence, investment process and long-term investment philosophy. When investors are resorting to tactics to sink individual ships, there is little chance for new, investor-friendly hedge fund models to emerge.