July 13, 2012 | Daily News Analysis
The Future Of Hedge Fund Investing
Here, Natalie Brod, partner at Crystal Capital Partners, outlines why the firm believes customization is the future of hedge fund investing. Views are the author's own but this website is grateful for permission to publish them. As always, responses are welcome.
The lost decade
The first decade of the 2000s are going into the history books as “The Lost Decade”of investing in the stock market. If you had invested one dollar into the S&P 500 on January 1, 2000 you would have lost 20 cents on December 31, 2009. However, for institutional investors who turned to hedge funds, the decade was still profitable, turning that same dollar into $1.851 (source: HFRI Fund Weighted Composite Index).
Winner takes all
The hedge fund industry can be seen as a “winner takes all” industry since the institutional firms in the space (firms with greater than $5 billion in assets under management) control the vast majority of the assets. Institutional-quality managers have a longer track record, a robust operational infrastructure, attract the best talent, and support clients’ demands for transparency. Unfortunately, they also require large initial investment minimums, reaching upwards of $10 million in some instances.
Diversification has long been a key tenet of successful investing. Therefore, smaller investors have historically bought into to the traditional fund-of-funds model to attain portfolio diversification with lower capital requirements. However, 2008 showed that the fund-of-funds model had risks as a result of their commingled nature, specifically pooled liquidity and pooled liability. A pooled vehicle implies that all investors in a fund share the assets, liquidity, and liability of that particular fund, which could result in liquidity dilution, delays and uncertainty during times of crisis. The liability incurred by one asset could potentially affect all other assets in the pool.
The future of hedge fund investing
One size does not fit all and investors need more customized solutions. Apple has been incredibly successful by building a platform that lets users choose their own songs for their playlists and choose their own apps for their iPhone. Google has been successful in letting users search for individual content and Facebook has been successful in letting individuals build their own social network. The hedge fund industry, on the other hand, has not been as accessible or customizable due to its high barriers to entry. Substantial resources are necessary to access managers, let alone to develop comprehensive analytical tools, thorough research reports, portfolio building technology, and consolidated reporting so that individual investment objectives and constraints can be attained.
It was these issues – customization and high barriers to entry –that motivated us to launch our Customized Hedge Fund Portfolio Program back in 2007. We were further motivated by the difficulties financial intermediaries, such as independent advisors, faced in incorporating alternative assets into their businesses. As a recent PENSCO survey shows, clients often have an interest in investing in a wider group of assets than bonds and equities alone, but advisors are challenged to find solutions.