Single-Strategy Funds of Funds Take Center Stage
Over the past few weeks, BHA analysts have noticed a considerable increase in investor interest in boutique, single-strategy funds of hedge funds. Of the 58 fund of funds mandates BHA has received, 30 have been for single-strategy funds.
Among both large, seasoned alternative investors and small, less sophisticated ones, there has been a consensus about their investments: what they thought were unique, uncorrelated, and specialized funds turned out to be slow and cumbersome juggernauts that were chiefly designed to gather assets rather than generate alpha.
In response to this revelation, investors are turning to highly focused and more nimble funds of funds that are built upon a track record of execution rather than a track record of fundraising. They are seeking specialized management teams that possess the proven ability to understand the underlying strategies and funds they evaluate, as well as the expertise to identify potential red flags.
An investment consultant based in Australia is currently seeking opportunities from funds of long/short equity funds. The firm’s clients have increasingly abandoned the multi-strategy approach for specialized, niche opportunities. The consultant is seeking teams that have experience in both fundamental and quantitative approaches. It believes that such teams have the knowledge necessary to understand funds’ strategies and how they are being executed, which in turn will help managers identify potential problems before they affect the portfolio in its entirety.
A large tax-exempt investor based in the U.S. is also seeking single-strategy funds of funds but in the fixed-income space. To qualify, managers must have more than three years experience operating a single-manager fund because the organization believes that only tested managers understand how to build out a clear and concise portfolio of underlying funds. There is more to a fund than just returns and volatility according to this investor; the details of a strategy, the level of risk management, and the cohesiveness of a team also determine if an investment will be a sound one.
Alternative investors are seeking experience and competence when evaluating funds of funds teams. The days of pumping capital into bulky, asset-gathering machines are over and small, specialized, and sophisticated investment managers are taking center stage.