Mainstream managers and hedge funds: battle joined?By Dr Arjuna Sittampalam, Research Associate with EDHEC-Risk Institute and Editor, Investment Management Review
In recent years, hedge funds have attacked the business of traditional asset managers, targeting their customers, both the institutions and the retail public. But the signs are that the mainstream is successfully fighting back.
Hedge funds going into these new territories have been driven by two important developments. Firstly, the UCITS III directive, which came into force a few years ago, allowed a version of hedge funds to be sold to retail investors under the much-prized UCITS label. Secondly, a large element of the hedge funds’ customer base, high-net-worth individuals, were put off in 2008 by their inability to withdraw funds from the hedge fund sector.
The hedge funds’ invasion of mainstream territory is being defended successfully by the traditional houses, which are also hitting back in hedge fund territory. According to Helena Morrissey, Chief Executive of Newton Investment Management, the well-known UK mainstream asset manager, many new clients, although not explicitly admitting to it, have come to them from hedge funds. The vehicles that the mainstream houses use in this battle are referred to as absolute return funds, which are very similar to UCITS hedge funds.
According to Naisscent, the hedge fund group, more than 1,000 hedge funds and absolute return funds are registered under the UCITS rules. Some of them charge fee levels similar to the 1.5-2% fixed plus 20% performance that is standard for hedge funds, but there are others that charge much less. For instance, Standard Life Global Absolute Return Strategies Fund, with over £8bn AUM, charges a management fee of only 0.75%. Institutions are attracted to these absolute return strategies by their offer of better liquidity, daily or weekly in contrast to hedge funds’ three-month lock up. Furthermore, the mainstream asset managers have better-established brands, and they pose less risk, because of lower leverage and better diversification.
Performance-wise, the absolute return funds have had mixed fortunes in comparison with hedge funds. In the 12 months to end-August 2011, the IMA Absolute Return Funds sector produced nearly 5%, and hedge funds just under 2%, according to Hedge Fund Research. However, in each of the years 2009 and 2010, the hedge funds’ performance exceeded that of absolute return funds by 12% and 7% respectively, though the former had fallen short of the latter in 2008 by 19%.
The concept attacked
Jeff Molitor, European Chief Investment Officer of Vanguard, says that the idea of absolute return is a wonderful concept, but that only a few of these funds deliver what is promised. George Mitton, writing in Funds Europe, wonders whether regulators should discourage the term.
Co-operation instead of competition
Schroders, one of the leading UK fund managers, launched Gaia, a platform for third-party UCITS hedge funds in 2009, and this had $1bn under management as of July, run by high-profile hedge fund groups, including Sloane Robinson, Egerton Capital, and CQS.
It is a well-established fact that only a minority of hedge funds deliver the performance promise of good positive returns year in, year out, irrespective of market cycles. In contrast to the bursting of the dotcom bubble, when hedge funds came into their own, outdoing the mainstream sector, the 2008 crisis showed up the vast proportion of mediocrities that had entered the hedge fund industry in the immediately preceding years.
The absolute return concept in theory offers the same package of positive returns independent of market performance, but Vanguard are right in asserting that achievement of this is not easy. It is particularly difficult because of the increased correlation of all asset classes since the crisis.
Absolute return funds are merely a new name for what used to be referred to a few decades ago as managed funds. Though it might be legally alright, there is a hint of a guarantee in the terminology that can be very misleading to unsophisticated members of the retail public. If the term can mislead, misselling can also occur. This type of misleading nomenclature does not do much to restore much-needed trust in the asset management industry. It is regrettable that even the top brands are using this terminology, attacked as it is by many unbiased thinkers. Fund managers should make it clear that the term refers to a benchmark of comparison against cash, rather than a market index, and does not promise or guarantee a positive return at all times. Customers should be made aware in unambiguous terms that even absolute return funds can go down as well as up. The safest way of achieving this is to abandon the title.
- "Fund worlds fight for their lives," Giles Turner, Financial News, 10.10.11
- "What’s in a name?", George Mitton, Funds Europe, September 2011
- Investment Management Review, January 2012