By Niki Natarajan
“Either there are Greeks in hiding, concealed by the wood, or it’s been built as a machine to use against our walls, or spy on our homes, or fall on the city from above, or it hides some other trick: Trojans, don’t trust this horse. Whatever it is, I’m afraid of Greeks even those bearing gifts.”
Virgil’s Aeneid, Book II
Talk to funds of funds about the challenges facing them today and most admit they are very afraid of the industry’s Trojan horse: the consultant. Tempting FoHFs to open their kimonos with promises of sticky asset flows from the institutional investor, the traditional consultant has been slowly and insidiously entering the FoHF arena.
So at the recent InvestHedge Forum, I was shocked to see that no-one stood up to call a spade a spade in the session called ‘Are the consultants eating the FoHF lunch?’ Historically, the traditional consultants have been the gatekeepers to the pension funds’ purse strings and, like the implicit trust one has for one’s doctor, many investors accept their consultant’s diagnosis without question when it comes to hedge funds.
The reason many FoHFs fear the advent of implemented consulting – direct manager selection and implementation for a fee – is not because it is more competition, which is after all the centrepiece of capitalism, but that it is conflicted competition. In one case, a consultant analysing FoHFs sits in the same pool of single-manager analysts.
How hard would a consultant really advocate for a FoHF investment if direct allocations make them more money? Even then, is the pension fund really getting the best selection if many of the best-performing FoHFs choose not to share their underlying portfolios for fear they will be copied, so resulting in exclusion from the approved list?
Clearly not all consultants are the same. Some like Callan Associates, say they only do FoHF searches and specialists like Albourne openly state they only advise on single managers. Others such as Northern Trust and Russell Investments – who used to have active consulting businesses have now opted for separate asset management divisions, and in the case of Russell a second go at hedge funds (see page 32).
A recent Prequin survey showed that 12% of alternative investment consultants exclusively offer discretionary services, 33% offer non-discretionary advice but a whopping 56% offer both services. As the general consultant steers his wooden steed towards asset management it must be observed, too, that many FoHFs are themselves cantering towards the advisory world.
None of this transformation, however, is about investor altruism; it is all about building a sustainable business model that earns fees. It seems that pure consulting is a dying industry.
In fact, as the investment world heads more towards a more solutions-based way of investing, a lot can be learned from EACM Advisors, which started life within the bowels of a consultancy called Evaluation Associates (see page 26).
Those inside the Trojan horse are the consultants that have secretly started offering direct allocations, while still offering FoHF advice. In such cases, who should the pension fund listen to? A consultant with little or no track record offering implemented consulting or a fund of funds, with a long-term proven commingled track record?
But the real danger both hedge funds and FoHFs face as they take the path of consultant is the ‘approved’ list. Generally operating from a low resource base, most consultants do due diligence on those they deem to be institutionally sound. Those that pass join the approved list, from which consultants direct their clients’ money.
As the cult of the consultant is relatively new in the hedge fund world, only those with a long-only institutional memory will remember the business risk of all of one’s money coming from consultants alone. Just as fast as the asset floodgates open to approved managers, so they can close.
A change in the investment team can result in a hiatus in assets, so what is going to happen when the founders of hedge funds start to retire? Institutional money may be sticky, but is the consultant’s loyalty to a manager assured?