Indeed, while U.S. advisors, who tend to be heavier users of mutual funds for liquid hedge fund strategies, have been increasing their allocations, U.S. institutional investors more used to traditional hedge fund structures have been cutting back from the latter: The Morningstar and Barron’s survey found that those expecting to allocate more than 25% to alternatives declined from 31% a year ago to 22% today. The survey report suggested they “may be tempering their enthusiasm as a result of fees, lockups and poor transparency in traditional hedge funds, as was the case with CalPERS’ announced decision to withdraw from hedge funds,” and these concerns came up when investors were asked what makes them hesitate before making alternatives allocations.
We believe that investors who are moving their exposure to hedge fund strategies into the regulated fund world are addressing these issues without throwing the baby out with the bathwater. Let’s take them one by one:
Fees
The typical fee for a hedge fund used to be a 2% asset-based management fee, with a 20% performance fee on top. Investing through a fund of funds at peak pricing could have added an additional 1% and 10%, respectively. Competition has brought costs down, but they remain high—and the addition of hurdle rates and high watermarks on performance fees adds complexity and variability.
While many UCITS still charge management and performance fees at higher, “hedge fund” levels, some providers are consciously bucking that trend and bringing fund expenses in line with typical U.S. practices. Although generally higher than those charged on most long-only mutual funds, management fees on alternative ’40 Act funds are generally set to compete with those on other specialist mutual funds, and are lower than fees charged by traditional hedge funds because they do not have performance fees, which are prohibited for funds offered to retail investors.
Redemption terms
Many hedge funds allow only monthly or quarterly redemption and often include longer-term lockups after initial commitments. During the stressed markets of 2008, some hedge funds “gated” redemptions, only allowing a certain amount of cash to be withdrawn at any one time.
Mutual funds are required to offer daily redemption at a fund’s next NAV. (Again, while this is required for U.S. mutual funds, it is not always the case for regulated funds in other jurisdictions.) While some of the less liquid parts of credit markets may be out of bounds for funds offering daily redemptions, a multi-strategy, multi-manager liquid alternatives product offering daily redemptions at NAV should have access to a substantial portion of the hedge fund strategies available, minimizing selection bias.
Transparency
Hedge funds often only report to investors once a month, with a delay, and position-level transparency is not the norm.
