Reinventing the wheel - the future for FoHFs
Funds of hedge funds have faced a challenging market context. Ian Lynch and Sean Moran of BNP Paribas Securities Services discuss how the industry has adapted and what the future holds.
Ian Lynch (IL): The FoHF industry has undergone a marked recovery since the financial crisis. This is evident from FoHFs’ AuM, which have rebounded following the fall-out from 2008. AuM year to date in FoHFs has increased by around 3-4%.
In 2008, FoHFs managed north of $800bn and this fell to approximately $500bn in the aftermath of 2008 amid major restructurings and investor withdrawals. Today FoHFs manage roughly $650bn, so there has been a recovery and we are confident AuM in the asset class will continue to grow. We have seen increased activity in FoHFs launches too.
Many of these FoHFs are providing niche and diverse product sets, often with specialist sector exposures. Others will offer investors access to start-up or emerging managers and niche hedge fund strategies. We have also noticed more hybrid FoHF strategies being launched, which in addition to having exposure to traditional hedge funds, will also invest in private equity, real-estate or equities, depending on the risk appetite and liquidity profile of their underlying clients. This helps give end investors greater diversification in their portfolios.
Sean Moran (SM): Many FoHFs have recognised that there were shortcomings in the pre-crisis business model and they have sought to rectify this. As such, FoHFs are tailoring their products and offering more bespoke investment services to their end investors. A number of FoHFs were guilty of over-diversification, which meant their underlying managers occasionally generated disparate returns and this ultimately hurt performance.
Nowadays FoHFs tend to have 15-20 positions in their portfolios instead of up to 30 or more, and this means the difference between the top and bottom quartile of managers is usually narrower. But most importantly, the surviving FoHFs have been in the business for a long time and have backed some exceptional managers, many of whom are now closed to external investment. As such, FoHFs can give investors exposure to best-of-breed hedge fund managers.
IL: There has been a spate of M&A activity fuelled in part by the inexpensive financing available in this low-interest-rate environment. A number of large asset managers are seeking to diversify and consolidate their investor base by acquiring FoHFs and there have been a number of high-profile acquisitions. Furthermore, Basel III capital requirements are resulting in shrinkage at investment banks and forcing banks to explore wealth and asset management as part of their search for return on equity.
Asset management, including FoHFs, is not a balance sheet intensive activity for banks and offers a number of opportunities.
SM: It is well-documented that some investors, particularly large European institutions, prefer onshore structures or are even contractually obliged to invest in only onshore entities. FoHF managers have recognised this trend and we are now witnessing an increase in launches of funds of alternative Ucits.
Some US managers, looking to distribute their vehicles to EU investors, are launching onshore funds of alternative Ucits in jurisdictions such as Luxembourg or Ireland. This is a growth market albeit one still in its infancy.
IL: The FoHF industry has undergone significant changes. While the asset class suffered from outflows in 2008, it has partially recovered. However, a number of service providers such as fund administrators and custodians have invested very little in their FoHF product offerings since 2009 and there is a feeling among FoHFs that they have been under-serviced by some of their vendors. This is despite the recent growth in the asset class.
BNP Paribas Securities Services is a top-tier provider offering a broad sweep of services including administration, financing and FX, catering to a diverse range of strategies including hybrid and onshore fund structures globally. Our commitment to FoHFs was reinforced in 2015 when we finalised our acquisition of the Prime Fund Services (PFS) business unit, which has an excellent working relationship with a host of leading FoHFs.