The suitability of hedge funds within institutional portfolios has been under debate since hedge funds first appeared in the market. Even though more institutions across Europe are now having some exposure to this type of investment, many are still concerned about risk, lack of transparency and other issues that in the past hedge funds have brought to institutional portfolios.
As part of the Excellence in Asset Management conference held in London in January, a panel of sellers, buyers and gatekeepers, discussed the role of hedge funds in institutional portfolios. They all agree on the fact that these products can add stability and diversification to portfolios, although admitted that these strategies do not suit everyone.
David Duncan, responsible for institutional business in Europe at GAM said: “What we have to think about is what purpose hedge funds serve. Generally speaking they are less volatile than traditional funds and having attended many pension fund trustees meetings I know that volatility is one of the things they are more concerned about.” He continued: “Also, some hedge funds are seeking absolute returns and, in the current market environment, this is also what trustees want.”
Duncan explained how hedge funds complement traditional funds, giving stability to the portfolio during uncertain times and “unfortunately as we all know uncertain times can be very frequent”.
However investors are still concerned about risk and capital protection. “In the hedge fund market there is a strong demand for products with capital protection, some times due to legal requirements. But do investors really need this protection when investing in hedge funds? Over a five year horizon the answer is probably no, it doesn’t make sense. Over a shorter time frame the answer could be different but I am not entirely sure,” said Michael Alzen, head of Asset Alliance, which manages areound $4bn in the alternative space.
“However in the last few years we have seen an important evolution in the use of hedge funds by institutions,” he added. “Investors start to invest in hedge funds using products with capital protection. This way they get to know how hedge funds work and what the risk is.” Alzen added: “Once they are familiar with the product they try different structures.”
Paul Audu, from HSBC Actuaries and Consultants and previously working for the London Borough of Hackney pension fund commented on the importance of manager selection when it comes to hedge funds. “Trustees need to select hedge fund managers very carefully, taking into account the skills of the managers and also the sector the fund is investing in. It is much more difficult to select a hedge fund manager than a traditional one, and this is one of the problems for trustees going forward.” He added: “Also sometimes short-selling is difficult for trustees because they don’t like the idea of selling assets they don’t actually own.”
Stephen Oxley, a partner at consultants Watson Wyatt said: “Institutional investors are different private ones because they are long-term investors with liabilities who are looking for complementary opportunities to the traditional asset classes. They need to understand the product very well and to have a high level of reporting and transparency.”
Oxley explained that for these reasons hedge funds do not fit everyone, and the most sophisticated investors are probably better prepared to have some exposure to these products. He also mentioned that the interest in hedge funds is encouraging more and more institutional asset managers to offer this type on investment as part as their product range, but warned that the fact that returns in hedge funds has been going down
“We will see institutional clients following a single fund approach in long-short strategies as part of the equity portfolio,” he said . However he pointed that if we continue seeing poor absolute returns in hedge funds, coupled with a revival of the equity market, the institutional money going into hedge funds in the near future might not as much as expected.
What is clear, that for those already investing in hedge funds, these products have proved to bring benefits to the overall portfolio, as an alternative to traditional investments. “After we have seen how the markets have been performing in the last few years, investors need alternatives,” said Chris Kemp from Carparo Group. “Investors are fed up with equities and are fed up with bonds and we need to take an alternative approach. Hedge funds could be one of the solutions, although they might not fit everyone.”

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