Investors want an explanation of the recent performance of strategies and some idea of how it will perform in current market conditions. For this reason, managers should send information about holdings, exposures and risk levels ahead of conference calls. “Then you don’t tie up the manager with a phone call of 40 minutes of data gathering, but drill down into the most important part of the relationship. And the hedge fund manager also benefits from this.” Pend ulum swings Hedge fund investors, including K2, did not miss their chance to extract better deals from managers. “There weren’t many hedge fund investors willing to step back in and invest in the depths of 2008 and early 2009, so hedge fund managers began to review their terms and conditions. We saw a willingness to discount fees, offer transparency into portfolios and provide better liquidity terms that match underlying investments, instead of long lock-ups just because they could,” Saunders says.

This has given investors greater clout in their negotiations with managers, and has led to some positive outcomes, according to Cambridge Associates. Managers have the opportunity to cultivate long-term, committed investor bases with an understanding of hedge fund strategies, Cambridge says, which could lessen the severity of another redemption cycle if global markets sold off rapidly again, or another fraudster of similar scale as Bernie Madoff was publicly uncovered. Cambridge has researched and consulted on hedge fund investing for more than 30 years, and its clients’ exposure to the strategies exceeds US$26 billion. Of the 10,000 or so hedge funds in existence, about 250 managers have successfully passed through its research and due diligence “funnel,” says Eugene Snyman, managing director of the consultant’s Australia office. In Cambridge’s experience, investors use hedge funds primarily to achieve diversification.

The strategies do not belong in growth portfolios, which are usually dominated by listed and private equities, or in defensive buckets built to hedge inflation and deflation. They are diversifiers aiming to generate positive compound returns, which are uncorrelated to public markets, over long periods of time. The ultimate goal, to gain equity-like returns with risk levels similar to bonds, still stands. “This portfolio can stand on its own, but its role is to diversify from the investor’s other assets and strategies,” Snyman says. He says investors with $30 million or more to allocate to the strategies can “be well diversified over 15 or so manager relationships” and build a direct program. In addition to customised strategy selection, these programs maintain a “liquidity schedule” which monitors the available liquidity among managers. But the resurgence of hedge funds has once again brought capacity concerns to the fore. Little more than two years since Lehman’s collapse, some top managers have already ‘soft-closed’ their funds to new investors, says Paul Liu, a hedge fund specialist with Cambridge, who is relocating from San Francisco to join the consultant’s Sydney team.