Hedge funds increasingly influenced by their institutional investor clients: report

Increasing numbers of institutional investors are entering hedge funds and driving the industry to provide more bespoke offerings, according to the Alternative Investment Management Association’s latest research.

More than half of survey respondents from the hedge fund industry said customized solutions are crucial to driving closer alignment with their investors, a major increase over the 14 per cent who said the same in AIMA’s 2016 survey. Among these more tailored options, the survey found co-investments with institutional investors are becoming more popular, with one in five respondents reporting they’re offering co-investment opportunities to private equity investors.

These co-investments can either be one-time investment opportunities within the larger scope of an overall hedge fund or managers can organize them as independent co-investment funds, noted the report “Hedge funds are more likely to retain investors and build goodwill with [these vehicles]. Often investors will allocate to a flagship commingled vehicle with an eye toward getting access to a niche co-investment opportunity with the hedge fund manager.”

Hedge fund investors are also eager to stand out from their peers, according to the report, and these types of flagship co-investments can be one way to signal that they’re dynamic potential partners for institutional investors. As well, when a hedge fund investor is very confident about a particular equity investment, but doesn’t have the capital to build a significant stake in the company in question, co-investment allows the investors to offer the benefits of that investment to others by leveraging their significant institutional capital.

Another key concern for hedge fund investors is building long-term, stable relationships with institutional clients, noted the AIMA. They’re especially keen to become closer to investors that won’t be thrown off by muted or negative performance in the short term.

“It’s critical for investors to gain insight into risk-adjusted measures of performance in their evaluation of hedge funds,” the report said. “For institutional investors, the ability of a hedge fund to add diversification to the overall investment portfolio and reduce correlation to broad market indices is typically a key consideration in assessing a fund’s performance. Metrics that capture the volatility of returns, the correlation of fund returns to an index or aspects of peak-to-trough value declines (drawdown) are all considered in manager selection.”

The report also found the increasing presence of institutional investors in the hedge fund world has improved its overall transparency. A balance in transparency is necessary, however, since hedge fund managers may have good reason to be reluctant to reveal too much about their strategies in the interest of maintaining their competitive edge.