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| Pruning the Thicket |
Storming the Citadel
John Ferry
12/01/2004
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Access to leading hedge funds has always been contingent both upon the size
of our investable assets and, more often than not, a personal connection with
the fund manager. When hedge funds first began to flourish in the 1970s (the
first debuted in 1949), investors often viewed their exposure in both social and
financial terms. “When we first started investing in hedge funds, there were
probably 200 to 300 of them, and you knew all the principal ones,” says Philip
Chapman, president of Adler & Co., a New York-based family office and
investment company. “Of course since then the hedge fund world has become
infinitely more complex. There are a lot more hedge funds, a lot more strategies
and a lot more money being put to work in the space.”
The expansion in both
the number of managers and in assets under management has made the industry much
more accessible. Yet, investing directly in funds run by the most highly
esteemed managers remains a challenge, even for those with large sums to put to
work. The most successful firms usually close their doors to new investors
shortly after launch to avoid being swamped with capital.
Pursuit by Proxy
For those who have neither the time nor the inclination
to stalk fund managers on the golf course or on the charity event cocktail
circuit, there are a few other options. We can delegate the stalking to
specialized investment consultants. These firms usually represent a pool of
investors, and because they bring to bear greater aggregate assets than do
individual investors, they often find it easier to form and maintain
relationships with leading fund managers. These firms can also advise us on how
best to allocate our capital. New York-based Hennessee Group, which represents
private investors and family offices with at least $5 million to $10 million
portfolios, has overseen the investment of $1.4 billion in client money—a
significant figure in light of the fact that the hedge fund industry has only
about $1 trillion under management. (Click image to enlarge)
“We can get into the better managers
because of our size,” Hennessee’s managing principal, Charles Gradante, claims.
“We are considered by hedge fund managers to be a sizeable pool of capital that
flows from the clients through Hennessee to the hedge fund managers,” he says.
“We know the players, and the players want to know us. They may be closed, but
they accept money from us because we represent individuals, and they prefer to
get money from individuals as opposed to a fund of funds.” Funds of funds demand
more information from, and oversee more closely, the hedge funds in which they
invest.
Autonomous Collective
While hedge funds may not prefer funds of
funds, individual investors clearly like their access, diversification and risk
management skills. “The funds of funds route—rather than direct investment—is
now the general access point for high-net-worth individuals,” notes Krishna
Prasad, a partner at S3 Asset Management, a New York-based fund services
provider. These diversified portfolios of hedge funds offer more consistent
returns with considerably less risk than individual funds. Between January 1990
and August 2003, funds of funds offered a 9.6 percent annual return on average,
which is slightly below the 10.1 percent return of the S&P 500 equity index.
Their volatility (a measure of its risk), however, was considerably lower.
Such returns are driving the assets that funds of funds manage to new highs.
Research by the Hennessee Group found that in 2004 funds of funds were the
fastest growing source of capital for hedge funds. The disadvantage to funds of
funds is the layer of fees they charge on top of the hedge funds’ fees. Another
way to access high-quality hedge funds is via banks’ or brokers’ capital
introduction groups. A number of leading financial institutions provide this
service to their hedge fund clients as part of their overall prime brokerage
effort. Capital introduction groups do just that—they introduce hedge fund
managers to investors. Start-up funds that are looking for seed capital find
them particularly useful. However, they are meant typically for institutional,
not individual, investors.
“Capital introduction groups in most cases do not
talk to high-net-worth individuals,” says a London-based head of capital
introduction at a U.S. investment bank. Since hedge funds in the United States
cannot market themselves directly to retail investors, it is too risky to bring
individuals and hedge funds together in this manner, he says. However, our
family offices may be in a position to take advantage of capital introduction
groups, as they often qualify as institutional investors.
 Back to Main Article: Pruning
the Thicket
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