There has been a lot of speculation recently about whether the hedge funds of funds (hedge FoFs) business model will survive the wash-up of the financial crisis. But many FoFs are changing what they offer investors – not just better transparency and lower fees. GREG BRIGHT spoke to Richard Keary, chief executive of the Australian arm of international FoF manager FRM about the trends.

Richard Keary has been active in hedge FoFs since the 1990s. He was the biggest supporter of local hedge fund talent using managed accounts long before the market clamoured for the transparency in managed accounts. He brought out one of the early offerings to the Australian market – of Grosvenor Capital – when working for the former Rothschild Australia and then oversaw its development at BT Funds Management after the Westpac associate acquired Rothschild. Now he is helping FRM (Financial Risk Management) through its evolution as an FoF manager, building bespoke groups of funds for very large institutional investors. FoFs of all sorts – not just hedge funds – suffered more than most managers during the financial crisis.

Notwithstanding generally good performance compared with the markets, doing what they were supposed to do, redemptions were heavy through 2008 and 2009 for hedge FoFs. Investors queried transparency, liquidity and the double set of fees. Since then, flows have returned, transparency and liquidity have been improved, or at least better explained, and fees have come down. And some super funds which want to make better use of their scale are looking to build their own FoF-like structures. The interesting question is: how do they do this? Keary says that investors such as super funds have the right to choose what to outsource and what to insource in all their investments, including alternatives. “There are fundamental activities that have to be resourced and the question is whether these can be acquired on acceptable terms to the investor.” Do pension funds have, or build, the internal capability, do they rely on their trusted asset consultant or engage new specialist consultants, or do they do a deal with a FoF to get exactly what they want? There is no right or wrong answer to those questions.

Keary points out that the current world economic environment is very unusual in the lack of consensus among genuinely clever people on the outlook, particularly whether inflation or deflation is the greater threat. He also points out that, before the recent uptick in bond yields, the real risk-free rate of return on US 10-year bonds was about zero. And the zero return to equity (both US and MSCI global indexes) for the past 10 years has come with a real volatility of about 25 per cent. The global hedge fund industry is back up to about US$1.6 trillion, according to researcher HFR last September, but still shy of 2007’s peak of about $1.8 trillion. And much of the recovery in assets is due to performance rather than new money flows. Keary says: “In general, investors have not come rushing back to hedge funds and new investors have been slow adopters since the crisis. Net inflows turned mildly positive in the second quarter of last year.

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