By Neil Wilson
Hedge funds have faced a lot of criticism over the past year
- as many have struggled to cope with the global financial
crisis. Not all of the criticism has been deserved, but we all
know it has been a difficult time and that conditions continue
to be very challenging.
The fund-of-funds sector has had arguably the most
opprobrium heaped upon it during this tumultuous period.
Although the mean returns from the single-manager universe were
deeply disappointing, coming in at around -15% last year, the
InvestHedge Composite shows that the median for funds of funds
- after their extra layer of fees - was, of course, even worse
at -16.63%. And, unlike at the single-manager level, only a
small minority of multimanager portfolios - mostly those with a
focus on specific strategies such as managed futures or macro -
were up for the year.
It was a year when the much-vaunted diversification benefits
of the multimanager approach simply failed to deliver in most
cases. And to add insult to injury, the year ended with the
revelation of the Bernie Madoff affair - which showed that all
too many supposedly sophisticated allocators had not been
clever enough to avoid the world's biggest-ever Ponzi
It would be surprising, therefore, if all of this should not
lead to some serious soul-searching within the industry - about
whether the fund-of-funds model itself is irrevocably broken,
or whether it needs to be reinvented, and, if so, how?
Clearly, a lot of lessons can be learned from the experience
of 2008. But, at the risk of flying in the face of conventional
wisdom, I will stick my neck out and say that this is certainly
not the end of the road for the multimanager approach.
For one thing, the statistics show that the industry still
has considerable scale. The latest numbers on the InvestHedge
Billion Dollar Club show that 137 fund-of-funds groups with
assets of $1 billion or more are still operating, and together
they had collective assets of some $744 billion at the end of
2008. This is down sharply - by about 30% from $1.1 trillion in
mid-2008. But when you add in the assets of the 420 or so
smaller multimanager groups, it is clear that about half of the
$1.8 trillion now being managed in hedge funds is still being
allocated via the fund-of-funds route.
As my colleague Niki Natarajan, editor of InvestHedge,
succinctly put it: "The industry has taken a serious beating,
but it is not an industry that is on the brink of
Significant consolidation appears inevitable as the boutique
players who cannot differentiate themselves in a crowded market
decide either to fold up or to team up with others. But it
seems to me that some niche players will remain - as there will
always be a need for those who can identify the skill sets
required in specific areas, such as emerging markets or
Again, I concur with Niki's conclusion: "A clear-out was
necessary, as there were too many sloppy practices in the
industry. Everyone, large or small, is going back to the
drawing board to make sure that their business can stand the
highest level of scrutiny."
Not surprisingly, many expect that those who had exposure to
Madoff will have a harder time - though for some, such as UBP
or RMF, the exposure was so small relative to their massive
pool of assets that they should be able to overcome it. In this
context, it is worth noting that only about 30 fund-of-funds
groups - out of 550-plus firms on the InvestHedge database -
are known to have had exposure to Madoff.
Thousands of other investors, including many high-net-worth
individuals, foundations and charities, invested directly or
via feeder funds. So when the dust settles on this egregious
Madoff affair, it is not clear to me that end investors will
conclude that the best way to invest in hedge funds is to go
direct and cut out the middleman.
InvestHedge held its annual awards dinner in mid-March in
New York. Attendance was lower than in previous years - down
from about 400 to just over 300 - which is not surprising
following a year of such negative performance. But again, this
does not appear to reflect an industry or sector that is
suddenly about to disappear.
For the awards this time, InvestHedge took the precaution of
ruling out of contention any fund that had exposure to Madoff -
though, given the quantitative method used for the ranking, it
is not surprising that hardly any funds that had had exposure
would have featured anyway. More interesting, and also worth
noting, is that only one out of the 20 winning funds from the
previous year had exposure to Madoff. This appears to show that
the methodology, although designed to reward those that achieve
a smoother return profile, also managed to weed out those that
tend to make the wrong sort of allocations.