The evolution among funds-of-hedge-fund managers

Timothy Schuler
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(Pictured: Timothy Schuler)

While many hedge funds delivered on their promise, or close to it, during the global crisis, changes have been afoot to their strategies and processes since.

Greater transparency and more backoffice resources to cope with regulatory changes and client demands have received most attention. However, there has been a more subtle change too. It is an acceleration of an earlier trend among funds of hedge funds (FoHFs) to provide bespoke services, such as discrete portfolios, and advice to big institutional clients.

One of the largest FoHFs, the Legg Mason affiliate Permal Group, with about US$22 billion under management, has gone a step further with some of its funds and managed accounts by negotiating specific bespoke mandates with some of its underlying managers.

Timothy Schuler, New York-based investment strategist and senior vice president, says that with its separately managed account platform, which speaks for 86 accounts totaling US$8 billion, only about half of the client portfolios mimic those of the underlying managers’ main funds.

This customization may be done through “carving out” an inhouse capability of the manager for a Permal client – an example being the litigious components of distressed debt portfolios – or by cherry-picking certain strategies from a commingled offering.

Permal has also been willing to invest alongside a manager in a particular security, he says.

Permal is represented in Australia by BNP Paribas Investment Partners, even though Legg Mason has a large office in Melbourne. This came about following the purchase of Fauchier Partners, a former BNP affiliate, which was finalized in March last year. The merged entity, which greatly expanded Permal’s non-US capability and client base, stuck with BNP as distributor in Australia.

More importantly for Australian investors, who have about A$800 million with the group, the Fauchier deal has meant inheriting a separate team in London, known as the ‘Jubilee’ team, which handles most of the non-US assets, depending on strategy.

Tim Haston, London-based institutional business development manager and senior vice president, who was with the Fauchier side of the merger, says the Jubilee product team manages the former Fauchier assets and money raised outside the US. The flagship Jubilee absolute return fund is a diversified FoHF with eight-ten different strategies.

With the managed account platform account exposures are divided into pari passu (co-investments) and customized vehicles. There is a wide variety of investment strategies with both established and emerging underlying managers.

Also importantly for Australian investors, Schuler says: “Because we are outside the purvey of the managers’ commingled vehicles we can offer negotiated [lower] fees.”

The double layer of fees had long been a bugbear for investors using funds-of-funds products generally. Since correlations tended to go to one for both diversified equity and bond funds and even for traditional balanced funds, during the crisis, there has been additional questioning of former fee structures.

Brad McCarthy, a managing director based in Singapore, says: “The way clients engage us now is through either a range of commingled vehicle through to almost a ‘co-pilot’ arrangement where they tap into our infrastructure and may even retain the ultimate investment decisions.”

In terms of the various mainstream FoHF strategies, Permal likes equity long/short as it believes it will continue to be a stock-picker’s market for a time. The firm also likes activist managers as a sub-set of event-driven.

Global macro, of which Permal has both a fundamental and a systematic strategy, has generally been a laggard in performance during the past two years, Schuler says, but it’s function is not to keep pace with equity markets.

“We’ve been dialing up our macro exposure,” he says. “The MSCI World [index] is in its fourth-longest bull run, without a 10 per cent correction, in 100 years … starting in June 2012.”

An example of how hedge funds can work in times when markets become highly correlated is the systematic version of the Permal macro fund, which was a top performer during 2008.

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