The funds of funds industry is struggling to regain investors’ confidence post-Madoff and the industry’s downturn in 2008. Funds of funds are currently dealing with the issue of scalability and a changing landscape of sophisticated investors clamoring for more customized products.
FINalternatives recently spoke with Joe Gieger, managing director of GAM Americas, about how institutional investors are crafting their hedge fund portfolios and what firms need to do to keep up with investors’ demands.
Can you give us an update on the firm in terms of its AUM and performance for the first half?
Assets were up 5% firm-wide for the first quarter. As of March this year, we have about $3 billion in our GAM Trading Strategy and another $2 billion in macro strategies within our multi-strategy portfolios for a total of approximately $5 billion. At the end of 2009, GAM managed $17 billion in funds of funds. We did not experience any outflows from our U.S. business.
We’ve performed inline with the rest of the industry during the last quarter. One of the things that we’ve done is not rely on a lot of beta within our fund of hedge funds portfolios. This is probably exhibited in 2008 when our low volatility product was down 10% and our Core Diversified strategy was down 15%. This year we’re pretty much in line with the rest of the managers out there.
The funds of funds space has faced some tough challenges within the past few years. What are some of the issues that funds of funds are currently working through?
Funds of funds are having scalability issues relating to the amount of resources it takes to put together a global portfolio. It’s more difficult to just be a U.S. centric manager these days so you do need a presence elsewhere in the world. You need the resources to not only fund the managers but to maintain the data on them and conduct due diligence on them. You also need separate lines of reporting and responsibilities so smaller funds of hedge funds firms may have difficulty doing that.
There have been cases where managers have also had to reduce their traditional 2/20 fee structures to attract more investors. Are you also seeing that within your portfolio as well?
We have seen some degree of fee reductions on the part of our underlying managers, but I don’t think it’s the most significant change that’s occurred for us. We have seen improved corporate governance, liquidity terms and levels of transparency. This is important for us because you’re never going to buy a manager because they charge the lowest fees.
It’s harder to start a hedge fund these days than in the past because of the uncertainty surrounding the regulatory environment. How much of your portfolio is focused on emerging managers and how do you source the next hedge fund stars?
As the makeup of the investment banking industry changes, you may see more people starting their own hedge funds. One of the myths is that we’re only invested in the big name hedge funds, but that’s not the case at all. Approximately half of our managers tend to be smaller and less than $2 billion in size.
GAM is willing to invest early in a manager, sometimes at inception. This is tied to the fact that we develop these relationships well before a trader has given serious thought of running their own fund. These traders are often either in an already existing hedge fund where they are not the most senior member, or on a proprietary trading desk. Should they decide eventually to start their own fund, we will have already established a rapport and have a good understanding of their approach as well as the potential fit within our portfolios. Alternatively, should they go to an existing hedge fund that we are invested with, we will have a view on how it might impact the profile of that fund as a whole to ensure it remains appropriate for us.
What key points do you think institutions need to understand when they allocate to alternative strategies?
The real question you have to ask yourself is do you understand the relative amount of beta that’s in your underlying portfolio. I think that’s the biggest lesson learned with portable alpha, which is actually a good idea. The key to getting portable alpha right is selecting an alpha source that doesn’t carry as much beta as your beta source. If you’re going to match up on the S&P 500 with a portable alpha strategy and you’re going to overlay an alpha strategy that already has a beta to the S&P of 0.6 - 0.7 in it, it’s not going to help in a big downturn, as we learned. But if you were going to match it to a strategy uncorrelated to the S&P, such as our GAM Trading Strategy, then that makes more sense.
How are institutional investors savvier in their current approach towards hedge funds given the lumps that their alternative portfolios have taken within the past few years? And how is GAM positioning itself in the institutional market?
Investors are now beginning to dissect the entire universe so they’re making sure they have the various styles covered and this is really heavily driven by the U.S. So institutions are gravitating to less correlated strategies such as macro. If they want to round out their exposure to China long/short managers, we have a strategy that can do that. If they want to round out their exposure to commodities-based CTA traders, we can help them do that. It’s more of a partnership approach than anything and we’re fortunate enough that we have single strategies as well.
There are a couple of significant corporate plans in the $100 million plus range who we’re currently working with through customization issues. There are also a few major public funds who are also engaging us for customized products.