By Susan Barreto
The hedge fund identity crisis still seems to be haunting an industry that is still desperately looking for cash. For end investors this has meant a parade of hedge fund strategies masquerading in a variety of costumes – including long-only, in managed accounts, multi-strategy and even customised products.
This is apparent in the InvestHedge monthly mandate tables that saw a number of hedge funds recently win mandates as dressed up as real-return or absolute return managers.
Some of the largest single manager mandates were awarded to groups such as Pimco, BGI/BlackRock, and Bridgewater in portfolios that are packaged under a variety of hedge fund like labels.
At the heart of the matter isn’t what managers choose to call themselves, but whether or not trustees actually know the difference between a hedge fund, a real return or an absolute return manager; and does it matter?
There are a number of sophisticated investors who say hedge funds are not an asset class but rather an investment management approach that can be applied across a portfolio. This may be true, but in its application there have been some sticky situations.
At public pensions, for example, there has been a move into direct hedge fund programmes augmented by real return or GTAA offerings that whether they know it or not are also hedge funds.
The politics of hedge fund investing has created new nomenclature among US public pension funds, plus the situation is not helped when consultants such as Mercer widen the hedge fund definition (see profile page 22).
In 2007, the $100 billion Texas Teachers Retirement System lost a battle with the state legislature to double the allocation to hedge funds. This means that to get hedge funds through the door they go by two different names – hedge funds and absolute return.
Both housed under alternative investments, hedge funds and absolute return strategies do share similar traits in the Texas Teachers’ portfolio.
According to the pension system’s annual report, a hedge fund is a private commingled investment vehicle with the general characteristics as set forth in Texas Government Code, Section 825.3012. By state law, Texas Teachers are allowed to invest up to 5% in hedge funds.
The absolute return portfolio in Texas is a broad category of investments that includes all assets that have “a high probability of generating a positive absolute return regardless of market conditions over a one to three year period”. The absolute return portfolio also includes hedge funds. In other words the absolute return portfolio can be home to additional hedge fund allocations that can be made outside of the 5% legislative constraint.
Random “politically correct” labels aside, hedge funds are defined broadly as a set of strategies that often include futures, options, leverage and shorting techniques and are structured as a private investment offering under set jurisdictional guidelines.
For pensions, new asset allocation strategies coming to the fore could create more practical problems with improper labelling. Investment philosophies – such as liability driven investing or risk parity – are dependent on investors analysing risk properly and much of that is dependent on calling a hedge fund a hedge fund in order to decide where leverage is safely applied. Is this a situation of don’t ask, don’t tell?
Lastly, investors need to know whether other investors are allocating to their same managers under the hedge fund or some other random label. Why? This is because down the road a manager’s portfolio could grow rapidly due to a new label and this impacts all investors’ future liquidity and capacity.
Managers may be dealing with an identity crisis or could just be enjoying the freedom of being considered for a variety of mandates in all the ambiguity but at the end of this costume ball it is up to investors to wisely define which manager they want to dance with in this new era of global markets.