By Niki Natarajan
When Harvard professor Clayton Christensen wrote The
Innovator’s Dilemma: When New Technologies Cause
Great Firms to Fail, Grosvenor Capital Management already had
some 25 years’ experience in hedge fund investing.
Had the firm, founded by Richard Elden in 1971, shared its
performance track record with InvestHedge over the decades, it
would have been part of this month’s feature on
'Lessons of the old and wise’, alongside its
fellow Chicago-based colleague, Aurora Investment Management.
Yet despite all the secrecy, with $22.3 billion under
management, Grosvenor is still currently the fifth-largest FoHF
in the world, and investors still seem to love it.
While Blackstone Alternative Asset Management, Goldman Sachs
Asset Management and Morgan Stanley grew their assets in 2012,
Grosvenor saw its assets slip down just slightly by 2.19%.
It’s not a big number and its performance is not
bad: for the year ending 31 March 2013, Grosvenor was up 8.4%
– compared to InvestHedge’s global equity
composite index, which was up 6.56% – according to
Oklahoma Police Pension and Retirement System’s
So what is the point of this editorial? Well, the point is
about the dilemmas facing FoHF investors as a whole.
A closer inspection of Oklahoma’s
strategy highlights the dilemma facing all FoHFs as
they try to adapt to their customers’ needs. In
the US at least, FoHFs it seems can be bought for a maximum of
85 basis points, while the expertise and knowledge set at FoHFs
has not changed, which is evident by Grosvenor’s
And this is not the worst part. As investors find the
'best’ route to direct investing, those opting for
the expertise of their FoHF can probably get their finely honed
skills for nothing other than the expenses of carrying out due
First published in 1997, Christensen’s analysis
suggests that successful companies can put too much emphasis on
customers’ current needs, and fail to adopt new
technology or business models that will meet
customers’ unstated or future needs. He argues
that such companies will eventually fall behind.
Could FoHFs end up sabotaging their businesses if they
continue to give their skills away? It is believed that
Grosvenor has similar low-to-no-fee advisory deals in place
with Texas Permanent School Fund and Sacramento County
Employees Retirement System, but they are not the only ones
taking this 'advisory’ route.
In terms of reinventing itself, Grosvenor does have the
Grosvenor Emerging Managers Fund and various strategy-specific
portfolios. It is also thought to be pursuing more liquid RIC
Neighbouring Aurora has already taken the plunge, along with
Arden Asset Management, into the liquid 40 Act market,
acknowledging the need for what Christensen calls "disruptive
innovation". Will the retail market be the saviour for
multi-manager hedge fund investing?
Right now Grosvenor, along with most of the FoHF industry
that relies on the institutional investor, is also facing the
prisoner’s dilemma. This was originally framed by
Merrill Flood and Melvin Dresher in 1950, but Albert Tucker
formalised a game format in 1992. Two prisoners are set to get
one year in jail, but privately each is offered a deal so that
if one testifies he would go free and the other gets three
years; if both testify against each other both get two
Applied to FoHFs – especially smaller ones
– each could gain important benefits from cooperating
or suffer from the failure to do so. But because it is
difficult or expensive, although not necessarily impossible,
few coordinate their activities to achieve cooperation as they
view each other as competition.
It is the end investor’s dilemma, however, that
has yet to manifest itself with this move to investing
directly. Once the hedge fund manager is selected there are
only two variables a pension fund can control: how much money
is invested and for how long.
What seems clear from all the pearls of wisdom of the FoHFs
with more than 20 years of manager-selection experience is that
the key to good long-term performance is compounding returns
– which, as Fundana’s Dariush Aryeh says,
means avoiding big losses. Surely this skill is worth paying