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 the
'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
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
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 years.
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
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 for?