Caveat emptor: beware of bespoke

Thu Feb 3, 2011

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As the trend towards bespoke or customised portfolios gathers momentum, it is probably time for InvestHedge to issue a health warning in case investors are hit with cyclical Alzheimer’s: Buyer Beware

By Niki Natarajan

My blood ran cold the other day to see a press release from one relatively unknown US-based private client fund of funds touting a long track record offering customised hedge fund portfolio solutions.

Normally such a firm would not stick in my mind. But a year or so ago, when attempting to follow up on reports that the group had invested in Madoff, we were met with unnecessary aggressive behaviour.

Caveat emptor –the Latin for "Let the buyer beware" – is really jargon for property law that controls the sale of real estate after the deal is closed. But it makes sense here too as some failed funds of funds are seizing the opportunity to try and re-invent themselves as bespoke portfolio providers.

And let’s not forget the consultants and their rapidly growing implemented consulting businesses – after all it was only a few years ago that a now defunct US consultant stuffed pension fund portfolios full of Amaranth.

Don’t get me wrong; I think that the bespoke/customised portfolio business is the natural next step in the evolution of multi-managers. But only hire those with a proven (successful) track record.

Groups such as Blackstone, Permal, Fauchier Partners, K2 Advisors and Morgan Stanley AIP have all proven themselves in the first phase of the industry’s development.

As Clark Fenton of Fauchier – which has been running customised portfolios alongside its award winning funds– warns, customisation is very demanding on time and resources. "One can get overstretched very quickly if one gets involved in too much," he says (see profile).

Pacific Alternative Asset Management Company and EIM are the pioneers in this bespoke field that, unlike Fauchier, opted to bypass the commingled stage and jump straight in. Listening to Paddy Dowdall at Merseyside Pension Fund, it seems that PAAMCO’s time has come (see profile).

Unlike commingled funds, bespoke portfolios do not come with track records, although EIM has opted for a GIPS compliant composite as its way to bring governance to what will become the new, but a lot less transparent, face of funds of funds.

I might be biased as I am hosting the 9th Annual InvestHedge FoHF Awards in New York next month, but there must be some form of investor comfort to be gained in knowing that there is some form of peer group performance benchmarking.

In the run up to this event, no fund of funds is safe as the back stabbing of what toxic trades or managers are contained in rival portfolios reaches the nadir of camaraderie. But in a way this almost childish self regulation is arguably an important way that the industry stays on the straight and narrow.

SEC registered FoHFs have to publish their underlying holdings, but in most bespoke mandates this is not the case. Through AP7’s public need for transparency, EIM proved that bespoke does not protect against investment failures, such Amaranth and Bear Stearns High-Grade Structured Credit Strategies hedge fund.

Nor indeed from outright frauds. Since finding Madoff in its portfolios, EIM, and its other pure FoHF cousins, have upped their game and gone the managed account route to keep better track of the content of portfolios.

While I am with Luke Ellis, the new head of Man’s multi-manager business, that bespoke and customisation is part of the future of funds of funds—this will be discussed in more detail at the Global FoHF Forum in New York on 10 March—very few will have the scale, people, process, expertise and infrastructure to even begin to contemplate bespoke solutions.

Before throwing the FoHF baby out with the bath water, take heed of the InvestHedge rule of thumb: if a manager did not excel as a fund of fund in the commingled field then it is probably best to avoid them like the plague in any new incarnation.

Ergo, caveat emptor: let the buyer beware.

ISSN: 2151-1845 / CDC10004H

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