Q&A: Fund of Funds Offers ‘Private Insight’ On Hedge Funds, Private Equity

Jan 17 2008 | 5:17pm ET

Private Advisors has big plans for its hedge fund and private equity businesses. The $3 billion plus fund of funds shop is currently working on its new digs in London, where the Richmond, Va.-based firm will begin working on a global p.e. investment strategy. The firm is also looking to add more managers to its smaller-market buyout fund, and is in the early stages of a finance-focused fund of hedge funds.

Private Advisor's Louis MoelchertPrivate Advisor's Louis MoelchertFINalternatives recently spoke with co-founder Louis Moelchert, the former manager of the University of Richmond’s endowment fund, about the firm’s investment philosophy and Private Advisors’ place in the alternatives arena.

FIN: Tell us about Private Advisors.

Moelchert: We currently manage in excess of $3 billion in hedge fund assets, but we started out with about $100 million from a few strategic investors. We currently manage four funds of hedge funds: diversified low volatility, diversified multi-strategy (including long/short), dedicated long/short and a distressed-debt fund of hedge funds.

Private Advisors' funds of hedge funds came first as we developed our capabilities, during a period of time when the markets were excessively bullish and we wanted to find a way to provide equity-like returns without taking equity risks and while avoiding the accompanying downside volatility. Our first effort in the market was a diversified low volatility, or "absolute return," fund of hedge funds, which did very well during the late 1990s.

Our distressed-debt fund was formed back in 2002 and was one of the first such funds in the marketplace. It's won two awards in the past year: first as distressed/event driven fund of the year, and then for U.S.-based strategy-specific fund.

FIN: So what makes Private Advisors a force to be reckoned with within the alternatives marketplace?

Moelchert: We think we're unique in that we have a primarily institutional investor base and we cover both hedge funds and private equity funds. Risk management and worrying about things that might go wrong is fundamental to everything that we do. We tend to be contrarian in that we're trying to find those niches in the marketplace that we believe will provide attractive returns for us in the future.

The other thing that distinguishes us from anybody else in the marketplace is what we call “private insight,” where we’re helping our individual hedge fund managers by getting information from some of the p.e. funds that we invest with. We had a long/short hedge fund that was short a defense contracting company and they wanted to talk to someone with knowledge of that industry. So we facilitated a call with a general partner of a p.e. fund that invested in defense contracting companies, and the p.e. firm advised the hedge fund that the large majority of the senior personnel team had top secret clearance by the Defense Department. This is an extremely valuable commodity and very hard to replicate.

Within 60 days of that call, that company was bought out and the hedge fund took their short off, saving them $15 million in client capital. Now, when that hedge fund asks their limited partners for additional capacity, they ask us how much we want rather than if we want it. Frankly, we don’t think anyone else can duplicate what we’re doing here.

FIN: Tell us a bit more about your risk management measures and what pitfalls you’ve been able to avoid as a fund of funds manager.

Moelchert: Typically we like 20 to 25 managers in fund of hedge funds portfolios. In our distressed-debt fund, it's typically a little bit less, with about 12 to 15. Over-diversifying is something we don't want to do: Turnover in our hedge fund portfolio has averaged less than 15% since inception.

Our risk management system specifically avoided a $40 million loss where we had identified a manager that had a high concentration in oil trading strategies. They were doing leveraged oil and gas trading, which wasn't what we hired them for. We redeemed approximately 18 months before that manager basically blew up.

FIN: You currently have three hedge fund products and are working on a finance-oriented fund of hedge funds. Can you give us a sense of what strategies you’re looking to avoid?

Moelchert: We do not like strategies that use excessive leverage, which doesn't mix well with unexpected events in the marketplace. We also don't like highly quantitative strategies based on someone's computer algorithm of what the markets might do most of the time.

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