Allocators have been under intense pressure to increase the performance of their hedge fund portfolios. As a result, hedge fund managers have been creating innovative solutions for the purpose of retaining existing assets and expanding their businesses. What innovative approaches have investors been seeing? How have managers been evolving to meet the needs of today?
Increased demand for lower-cost beta strategies has put pressure on active managers to provide higher returns at lower-cost. Hedge funds have been a particular focus as investors reassess how alpha-generating strategies should fit in their portfolios and how much they are willing to pay for them. This pressure to increase performance while reducing costs has been a catalyst for creativity and innovation across the hedge fund space.
Areas of innovation include new approaches designed to increase returns, investment expansions into new markets, and business expansions via new fund structures. The views expressed herein were shared by different investment consultants, fund of funds, and wealth management firms.
Co-invest funds are being offered across single strategy hedge fund managers - most prominently with long/short equity and event driven strategies. Multi-strategy managers have more capacity than single strategy managers and, as a result, are less likely to offer co-invest funds.
To prevent the cannibalization of their long/short strategies, some managers have been pairing their new dedicated long-only funds with their long/short funds. The rationale is that the blended return from both funds will be higher due to increased beta and reduced fees.
Other managers have been marketing long-only carve-outs as stand-alone strategies. Fees for these funds include: (i) 1% management fee and 15% incentive fee, (ii) 1% management fee and 20% incentive fee, and (iii) 0% management fee and 30% incentive fee. Additionally, some performance fees include hurdle rates.
Fee reductions may also come in the form of loyalty discounts for long-time investors. For example, investors of five years or more may be eligible for the following investor-level AUM breakpoint discounts:
|AUM Breakpoint Discounts|
|$200MM or higher||0.30% management fee reduction|
|$75-200MM||0.20% management fee reduction|
|$25-75MM||0.10% management fee reduction|
|$25MM or less||0.05% management fee reduction|
To capture new capital inflows, some systematic managers have developed hedge fund replication strategies, which have fees that are significantly lower than their hedge fund counterparts. These newer funds have largely been event-driven replication strategies and come with a flat fee of 1.00%.
Another way investors continue to offset fees is by providing managers with seed capital. In return, they receive the benefits of ownership interests in the management company for a period of time. Investors have found that these revenue sharing arrangements continue to be an effective tool to lower their fees, which increases net returns on their investments.
In order to help investors increase portfolio returns, several hedge funds are offering tax-advantaged strategies, which generate substantial short-term capital losses. These loss carry-forwards can be used to offset gains in other parts of investor portfolios (which, when blended together, reduce portfolio-wide tax liabilities). These strategies are currently being offered by systematic equity market neutral managers, who have tweaked their existing code to facilitate short-term losses.
Platform currencies do not have absolute values. Just like fiat currencies, platform currencies are valued on a relative basis (relative to other currencies). For example, the price of platform currency Bitcoin will increase relative to the U.S. dollar when investors sell their U.S. dollars to buy bitcoin. On the flip side, the price of the bitcoin will decrease relative to the U.S. dollar when investors sell their bitcoin to buy U.S. dollars.
Currently, blockchain platform currency investment funds are long-only investment strategies. Managers convert capital from an investor’s fiat currency (e.g., U.S. Dollars) into different platform currencies. The strategy is to wait until the platform currencies appreciate significantly (on a relative basis) before converting the platform currencies back into the original fiat currency.
Since this space is relatively new, investors are waiting on the broader adoption of platform currencies by consumers before seriously considering investing in the space. Other investor considerations include whether it makes sense to own platform currencies as a stand-alone investment. For example, with equity and debt instruments, investors still have ownership in the issuer or claims against the underlying assets of the issuer. However, when owning platform currencies alone, investors do not have ownership or a claim to any other associated assets.
In the wealth management space, early adopters of interval funds selected these strategies for:
Wealth management firms currently exploring the interval fund space have the following concerns:
In the opinion of some wealth managers, mass affluent investors run the risk of investing in hedge fund-like strategies that provide lower returns and come with much more restrictive liquidity. Additionally, mass affluent investors may not realize how illiquid these strategies are, which may lead to intense dissatisfaction with interval funds and their advisors during market shocks.
To address these concerns in the interval fund space, some managers have mandatory training programs for wealth management firms, including:
This way, wealth management firms can educate their clients on strategies, liquidity, and when to increase their fund investments.
Investors will continue to reassess how alpha-generating strategies should fit in their portfolios and how much they are willing to pay for them. In order to meet the needs of today, hedge fund managers will continue to create innovative solutions to retain existing assets and expand their businesses.
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