Investors wish for liquid hedge funds

In the current economic uncertainty, pension funds and other institutional investors are increasingly turning to liquid hedge fund strategies as they seek to have easy access to their money in shifting conditions.

 

Wishing well: investors seek more liquid strategies such as global macro or managed futures 

In a survey last month of institutional investors by data provider Preqin, 12% of respondents said that during this period of volatility they were exclusively looking at liquid investment strategies in their hedge fund portfolios, while 30% would not consider funds that have a lock-up period.

Olivier Cassin, head of research and development at investment consultant bfinance, said: “When there’s uncertainty in the market and heavy government intervention on monetary and fiscal policy, for most of our clients, access to capital outweighs the illiquidity premium that comes from locking up capital. Right now investors desire liquidity far more than the opportunity cost of potentially missing out on a few percentage points of performance.”

Greg Clerkson, director of alternative investments at consultant Russell Investments, said that while there were good opportunities to invest in credit hedge funds, investors were not willing to lock up their money in the face of the current economic uncertainty. He said: “If you go into more liquid strategies such as global macro or managed futures, you can get your money back quickly and, historically, both have shown some degree of equity offset. It’s optionality as much as anything. Historically, it has worked and if it doesn’t work you can get out.”

Economic trends

Managed futures strategies use computer models to try to capture trends in a range of global markets. Global macro is a strategy that trades instruments such as currencies, interest rates, foreign exchange and bonds to take advantage of broad economic trends.

Guy Saintfiet, UK head of liquid alternatives at Aon Hewitt, said that for the past 12 months his firm has been advising clients to add more exposure to global macro and managed futures. He said this was driven by investment opportunity, not liquidity and added: “We believe that these strategies are best placed to capitalise on an environment where markets are driven by high-level newsflow and are not trading on bottom-up fundamentals.”

Saintfiet said that since the financial crisis, pension funds had been focusing on more appropriate liquidity rather than more liquidity. He said that their reaction to Ucits funds, a regulated structure that gives clients access to their money at least twice a month, reflected this. Saintfiet said: “We’ve had very little interest in Ucits from pension funds. In return for the higher liquidity, you typically give up quite a lot of return potential and they don’t want to make that trade-off.”

With assets in the roughly $2 trillion hedge fund industry reaching new highs, the composition of the investor base has changed significantly since the financial crisis. Preqin estimates that 61% of hedge fund capital comes from institutional investors, compared with 45% before the crisis.

Three quarters of respondents to Preqin’s survey said they needed greater liquidity in their hedge fund portfolios in the post-financial crisis period than they had needed previously.

According to Robert Howie, head of alternative investment at consultant Mercer, this is unsurprising. He said: “I can see why there is a focus on liquidity. During the crisis, clauses were suddenly invoked that were very vague and many investors found themselves dealing with gates, side-pockets and suspended redemptions.”

Howie said that investors should look to see that the fund’s liquidity matches its underlying instruments. He said: “Moreover, liquidity is not something that is constant. Investors need to understand what managers will do if their instruments and markets become illiquid.”

Clerkson at Russell said that investors had become much stricter on insisting that the investment mandate should fit the fund’s liquidity terms. He said: “We will give you the discretion but we will put the rules around it. There’s very little benefit of the doubt to be had. Investors have become less tolerant of managers going outside their mandates. There’s very little appetite for a supposedly liquid product with an option to go illiquid without the investor having the call.”

From a manager’s perspective, pension fund capital is attractive because it is perceived to be stable and long term in its mindset. But consultants said that pension funds were keen to ensure that their long-term outlook did not leave them at a disadvantage. Aon’s Saintfiet said: “Institutional investors need to worry about being liquidity providers to a failing business or to other investors with a shorter-term time horizon. During the crisis, people who were locked in for longer ended up holding the baby and the cost for them was much higher than the fee discount they received.”

Investor lock-in

Saintfiet said that pension funds were avoiding managers looking to protect their businesses with overly harsh liquidity terms. He said: “Our focus is on identifying the best managers with appropriate liquidity and a stable client base of preferably institutional investors. There has to be a good reason to lock in your money for longer. It is not really good enough when it’s just about protecting a firm from redemptions and being the last one out.”

Clerkson said: “An investor-level lock is perceived as something that only benefits the manager. Sometimes there is a good reason for it but investors need to understand the rationale.”

Is there a danger that investors are missing out on some good investment opportunities by insisting on investing in liquid strategies? Cassin at bfinance said: “In dislocated markets, there are a lot of opportunities for those with cash and time on their hands.”

But he said that, while pension funds are mainly investing their hedge fund allocations in liquid investments, elsewhere they are more willing to forgo access to their money and gain exposure to the greater returns this can bring. He said: “At an overall portfolio level, we’re seeing a search for yield that is leading investors to look at real assets such as infrastructure, real estate and some private equity. We also see many attractive direct and secondary opportunities at the moment.”