Surviving funds of funds are like finely-tuned cricket bats

Thu Jun 3, 2010

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Funds of funds are now offering customisation services to investors that have realised that DIY hedge fund portfolio construction might be cheaper, but is not always better


By Niki Natarajan

We live in a DIY age of Home Depot and B&Q and yet kitchens and bathrooms that are crafted by an expert typically last longer, cause less stress to the family and work just that much better. There is, of course, a cost for expertise.

But, as IKEA now offers professionals to fit the kitchens bought in the store, so too are funds of funds offering customisation services to investors that have realised that DIY hedge fund portfolio construction might be cheaper, but is not always better.

Funds of funds such as K2 Advisors, Morgan Stanley AIP and Blackstone Alternative Asset Management have entered this new "Age of Customisation" - a space that PAAMCO and EIM have dominated for years - and are now offering portfolio completion and customised portfolios.

Advisory work used to be considered a low-cost B-list service that many groups phased out. But following the entrance of groups such as Aksia, there has been a revival of this form of hedge fund portfolio service.

It is the natural next step for established funds of funds to have the starter packs for novice investors, and strategy-specific offerings for the sophisticated multi-manager aficionados. After all, they have already invested in the infrastructure of research and due diligence.

And now, for a 'consulting' fee, they can either put the hedge fund portfolio together from scratch or, even better, take a look at the whole alternatives portfolio and add in the bits that are missing.

Investors are right to query fund of funds fees, but what they need to realise is that not all funds of funds are born equal. In his book Outliers, Malcolm Gladwell analysed the skill set of the genius, and concluded that what the genius always has is 10,000 hours of expertise in the field.

So why do newcomers think that they can spot a winner, a fraud, or an ego-led accident waiting to happen better than the veteran due diligence teams with 10,000 hours on their CV?

The Madoff-effect has been like a monsoon sweeping away the debris, leaving only those left that truly deserve to be called multi-manager experts. In a session entitled Passion and Performance: What really drives sustainable FOHF returns? at the InvestHedge Forum, taking place in London in September, we will examine the secrets of the genii with more than 10 years' experience to find out what makes them stay top performers.

If you take off weekends and holidays, it is these funds of funds still run by the founders that have invested more than 10,000 hours that are the winners. It is this kind of expertise that can, and should, still charge fees - to pay for due diligence, market intelligence, manager selection and asset allocation.

As Henry in Tom Stoppard's play The Real Thing, explains: "This thing here, which looks like a wooden club, is actually several pieces of particular wood cunningly put together in a certain way so that the whole thing is sprung, like a dance floor... If you get it right, the cricket ball will travel two hundred yards in four seconds, and all you've done is give it a knock like knocking the top off a bottle of stout, and it makes a noise like a trout taking a fly....

"Now, what we've got here is a lump of wood of roughly the same shape trying to be a cricket bat, and if you hit a ball with it, the ball will travel about ten feet and you will drop the bat and dance about shouting 'Ouch!' with your hands stuck into your armpits. This isn't better because someone says it's better, or because there's a conspiracy...it's better because it's better."

And so too are the fund of funds experts with great performance year after year.