The reasons for investing in hedge funds in the first place, namely absolute returns, additional alpha, reduced beta and non-correlation to broad market benchmarks, failed to materialize in 2008. Undaunted, institutional investors on the whole are planning on maintaining or increasing their asset allocations to hedge funds and funds-of-funds according to research performed by SEI and Greenwich Associates.
Concerns About Hedge Funds Remain an Issue
There are, however, concerns going forward with investment in hedge funds; not the least of which is the alleged Madoff ponzi scheme. In addition, lack of transparency has been a concern for quite some time.
There is no shortage of ego on Wall Street and hedge funds are at the top of the list. The secrecy most exhibit has manifested itself in this lack of transparency that is now serving as counter-productive.
The third major concern is not only poor performance but coupled with correlation to broad market indices or benchmarks.
Realignment of Hedge Fund Strategies
While concerns are noted, the desire for diversification along with non-correlated, absolute returns, institutional investors are sticking with hedge fund managers.
Many institutional investors are taking a long-term view of their commitments to hedge funds, with time horizons ranging between three to five years ahead. Strategies by managers favored are multi-strategy, event-driven and market neutral while eschewing emerging markets and convertible arbitrage.
Revised Criteria for Investing in Hedge Funds
Increased scrutiny is certainly a prime concept going forward with stringent standards to be met for:
A) Capability of the professional staff
B) Consistency of philosophy
C) Consistency of decision making process
D) Increased level of transparency
E) Track record
F) Assets under management
In addition, look for more due diligence concerning:
A) Counter-party risk
B) Operations
C) Risk management
D) Compliance
Within all of these various criteria, the level of importance can and does differ significantly between North America, the United Kingdom, and Continental Europe.
For example, the reputation of the fund is head and shoulders more important in the U.K. than it is in the U.S., while Continental Europe splits the difference. Length of track record is more important in Europe than in the U.K. or U.S. While assets-under-management ranks pari-pasu with each of these three regions, dedicated people in key positions and support staff is far more important in the U.K. than the U.S or Europe.
Give Hedge Funds a Second Look
We have a situation now where "Joe-the-plumber" is bailing out the Ivy Leagues finest.
Despite recent scandals and poor / correlated performance, hedge funds are a long way from dead. Institutions are increasing their level of due diligence; perhaps you should as well.
Dean Lundell - A capital markets professional with over thirty years of experience and a licensed Commodity Trading Adviser.
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