Funds of Hedge Funds: 'A Diminishing Slice Of a Growing Pie'

As the Wall Street Journal pointed out earlier this week, “It may be premature to write the epitaph for funds of hedge funds”.

Maybe so, but with predictions for redemptions running in the high teens for this fall, one would be excused for believing the hedge fund “bubble” has burst along with the many other bubbles inflated over the past few years.

Yet, WSJ sister publication, eFinancial news reports this week that: “Pensions Continue Push into Hedge Funds”.  This seems to back up what research firm Cerulli recently concluded - that institutions are continuing to move from long-only to alternative assets (see Monday’s post for clear evidence of this).

Dow Jones points to the UK’s University Superannuation Scheme (USS) as one example of the new and more grounded institutional view of hedge funds:

Michael Powell, head of alternative assets at the pension scheme, said: ‘The turbulence in the hedge fund industry has provided USS with a great opportunity as a new entrant. The fallout in the industry will also prove to be a great arbitrator of quality and skill among the huge number of hedge funds.’

Meanwhile, Phil Irvine, co-founder of PiRho Investment Consulting along with AllAboutAlpha.com contributor Nicola Ralston told The WSJ there would be:

"…great opportunities for whatever funds are remaining, and the opportunities will be larger than they have been for some time”.

Ralston echoed our comments yesterday about relying on the citizens of Lake Wobegon for investment advice:

Just because you are with a big name does not mean you are any more protected in terms of returns. The bandwagon effect of having a very large fund or name where money starts flowing out can be very unpleasant. Behaviour says people feel less vulnerable when they have chosen a big name, even if that big name lets them down. However, you are not more protected by scale or brand.

So how can the hedge fund business be shrinking at the same time that institutional investors are starting to come around?  Robert Howie of Mercer is quoted in both stories and reconciles these two apparently opposing views of the world:

• Howie in Pensions continue push into hedge funds: “A number of our medium and large clients have made allocations, and there are allocations in the pipeline.”
• Howie in Funds of funds facing unprecedented withdrawals: “…funds of hedge funds would survive, but take a “diminishing slice of a growing pie” as institutional investors and other sophisticated allocators launched their own investment programmes.

So at the end of the day, the major change coming out of the credit crisis may have more to do with how investors allocate to hedge funds, not whether they do so.