During the past several weeks, BHA has interviewed an increasing number of investors that are sitting on a substantial amount of dry powder and are now deploying capital to niche, uncorrelated, and unique hedge fund strategies. These investors have stressed that funds employing traditional alternative investment strategies are of little interest; the past year has proven that such funds are correlated to the market, rather than uncorrelated as claimed.

The chief investment officer at a multibillion-dollar investment firm has been actively searching for hedge funds using strategies other than equity, credit, and fixed income-traditional strategies that have been heavily affected by the global recession. The firm is looking for new and unique asset managers that are operating in fields unaffected by financial markets. Some examples of the types of opportunities they are looking for include MLP’s, intellectual property, re-insurance, tax liens, commercial litigation, film finance, and other completely uncorrelated investments.

This same sentiment is being echoed by wealth managers, endowments, and foundations. The managing director of a multibillion-dollar U.S. endowment is anxious to diversify the portfolio; however, the endowment will allocate only to funds that will remain unique and niche in their strategies and return streams.

Investors recognize the significant value in having an alternative portfolio as long as it is uncorrelated to the rest of their holdings. However, instead of investing in hedge funds that are uncorrelated in theory, they are demanding funds that are uncorrelated in practice. To this end, using the increase in transparency, investors are monitoring managers’ positions to ensure that they are providing the niche and unique return streams as advertised. For managers that can deliver on their promises, there is a long line of investors ready to diversify their portfolios.

During the past month there have been numerous articles written in financial journals and newspapers regarding the intensified effect that the global economic downturn is having on emerging markets. Developed economies are struggling to combat rising unemployment and tightening credit, and that, in turn, has had an exponentially negative impact on emerging markets that rely on developed growth for support. However, this grim news has not deterred alternative investors. During the month of March, BHA interviewed 69 alternative investors that said they were targeting emerging markets-focused funds; 36 of those investors were explicitly searching for emerging markets-focused hedge fund managers.

If developed markets have been battered over the past couple quarters, emerging markets have been crushed. However, in the hedge fund space the HFRX Emerging Markets Index is down only .5%. Alternative investors appear to be taking notice of this gritty performance, and there is a very high degree of risk and opportunity in this space.

With valuations so low, investors are recognizing an opportunity to move into emerging markets in anticipation of the return of rapid growth that investors saw before the current crisis. The director of research at a U.K.-based consulting firm that manages over $1 billion in client assets is actively seeking global macro managers that are currently
specializing in emerging markets. Because emerging market investments have inherent risk, global macro managers are uniquely positioned to move in and out of different strategies. Managers that can shift with volatile emerging economies have an opportunity to acquire drastically undervalued assets and enjoy the upside as developed markets recover. Emerging markets funds are difficult and risky as they tend to be more volatile then funds focusing on developed stable markets. However, with nearly 70 investors during the month of March alone indicating their renewed interest in emerging market funds, there is a clear mandate for these types of managers despite current headlines.

Diversification has always been a standard way to hedge risk in any investment portfolio. Whether diversifying across sectors, strategies, or geographic exposures, investors are looking to minimize their downside risk. BHA’s data provide compelling evidence that global diversification is becoming a prevailing theme among investors interviewed by analysts during the past quarter. Entering the final month of Q1, investors are looking to allocate nearly 36 percent of every hedge fund investment mandate to a globally diverse hedge fund.

This means that more than one-third of BHA’s hedge fund investment mandates are focused on funds that do not have a specific regional focus. Globally diverse funds have the advantage of not being bound to and adversely affected by the potentially isolated economic conditions of a particular region. One U.K.-based wealth advisor that manages several billion in assets specifically outlined its desire to only invest in funds that are globally diverse and not confined to and restricted by regionally specific investment parameters. Hedge fund investors are looking for funds that can make quick tactical movements in difficult market environments. A fund that is globally focused is able to exploit opportunities no matter where they occur and can have a competitive advantage over its regionally focused peers.

During the past two months, country-specific-focused funds have seen a dramatic drop in interest from investors compared to globally focused funds. In fact, the U.S. is the only country that garnered double digit interest from investors. Countries like Africa, China, India, and Japan were mentioned in under 5 percent of the investor mandates that analysts collected. It appears that the prevailing theme of the first quarter in terms of geographic interest and focus is that investors are concentrating on investing in nimble and diversified positions with a global capacity to achieve absolute returns.