INSTITUTIONAL INVESTORS SEEN CONSTRAINING HEDGE FUND MANAGERS.
—Nathaniel Leclery
Traditionally, hedge fund managers have been expected and often encouraged to tweak their investment style to profit from market conditions. In many ways this flexibility allows hedge fund managers to post returns well above those produced by traditional managers. But ever since more traditional institutional investors have entered the market, hedge fund managers have had to walk a fine line when adjusting investments. Pension plans are for the most part, cautious when investing in hedge funds—and one of their top concerns is that they know what style managers are following, said Jim McKee, consultant at Callan Associates. These investors can be quite intolerant to shifts in style, he added.
The mix of new and seasoned institutional investors and high-net-worth individuals is presenting hedge fund managers with an investment conundrum: the affluent and more seasoned institutions are more open to style shifts than the newer institutional investors. Public pension plans, in particular, are quite leery of any tinkering with style, said Mark Lucas, hedge fund manager at Globel Investments. To compound the situation, these often-new-to-the-sector investors tend to invest in small quantities that do not warrant separate accounts, leaving them commingled with investors who are comfortable with the managers making adjustments to style. The more seasoned investors will often seek hedge funds, in part, because they can—and do—adjust strategy, he added.
Pension plans hire hedge fund managers to fill a specific role within a greater portfolio, said one pension plan official. If the manager wanders too far from this role, it ceases to be useful within the scheme of the larger portfolio. Sponsors have too often found themselves choosing a hedge fund to fill a niche only to have the manager change to a more aggressive style, he added in explanation as to why the sponsors are so intolerant to style shifts. As an example, he cited the case of a market neutral manager that had a slight overweight to technology that helped returns during a market rally but dragged performance significantly when the market turned. “This isn’t suppose to happen in a market neutral portfolio,” he added. Hedge fund managers for the most part agree this is not suppose to happen but point out that it is often times inevitable. Globel Investment’s Lucas said hedge fund managers often move out of traditional money management shops for this added flexibility. “It’s what separates us from the rest,” he added.
Detecting Drift Changes in style can be subtle and difficult to pinpoint. Fund of fund managers will usually speak to hedge fund managers on a monthly basis to determine if anything has changed, said one consultant, who declined to be named. Hedge fund managers, for the most part, tend to be more open when speaking with fund of fund managers because they know they will tolerate a certain amount of style drift without too much concern. But when dealing with consultants representing pension plans that are concerned about any change in strategy, managers tend to be more tightlipped, he said. Managers are providing increasing transparency, but it is still difficult for a consultant to be sure by looking at a report that a market neutral manager is not extending himself, he added.
Hedge fund managers gradually change investment styles over time to adapt to market conditions, said Joel Katzman, president of Chase Alternative Asset Management. For example, merger arbitrage managers have started to increase their allocation to European deals following the surge in new deals taking place abroad. Some institutional investors consider this style drift, Katzman said, adding he viewed it only as an evolution of a manager’s style. Other changes in investment style can be more pronounced. During the rally in tech stocks in the past years, many hedge fund managers, from emerging market managers to managed futures advisors, began adding tech stocks to improve performance, said Virginia Parker, partner at fund of funds Parker Global Associates. This type of style shift can increase a portfolio’s exposure to one sector and alter its risk profile. Some market neutral managers have also been guilty of some style drift in the past year, said Alan Gasiorek, treasurer at BellSouth. He said some market neutral managers overexposed their portfolios to the tech sector and to smaller companies and have struggled to post stable returns lately amidst the recent stock market selloff. “If they had properly set up their portfolios, this would not have happened,” he added. |
