The continuing rise of hedge funds in terms of both the number of funds now available on the market and in their growing track record of good performance, raises the question of how fund managers will distribute their hedge funds products in the future.
To date, hedge fund managers have mostly operated outside the realms of master trusts and wrap accounts.
According to Colonial First State head of hedge funds Damien Hatfield, most investors currently access hedge funds via direct investments, with 70 per cent of Colonial’s hedge fund inflows deriving from direct investments.
The main reason why direct investment has been the chosen form of distribution for many hedge fund managers is because to list a hedge fund product on a master trust requires some tweaking to asset allocations.
While fund managers say master trusts are not hindering the development and take-up of hedge funds, they are keen to make their products more attractive to the master trust market.
Hatfield says one of the challenges associated with working with a distribution vehicle such as master trusts is the illiquid nature of hedge funds.
He says due to the asset allocations of some hedge funds, the ability for these funds to fit in with the quarterly redemption cycles of most master trusts, creates a mismatch between the products.
Hatfield says up to 40 per cent of hedge fund managers run quarterly redemptions, while other managers offer daily and weekly redemptions. The particular redemption cycle of a master trust will in turn impact on the asset allocation of a hedge fund should they want to list on a master trust product.
“I don’t think it’s a major impediment. As the community starts to accept [hedge fund] products, there will be more demand to be on master trusts,” Hatfield says.
Sagitta Wealth Management director Stephen Karrasch describes the above challenge as the technical constraint of trying to list hedge funds on master trust products.
He agrees with Hatfield that while the redemption cycle of most master funds is 30 days, meanwhile hedge funds work to a quarterly redemption cycle.
Karrasch says given this gap, Sagitta will move to a monthly redemption cycle next month for both its Rothschild Global Return and Rothschild Total Return hedge funds. However, not all hedge fund managers are able to make this transition.
“If the assets in the investment are illiquid, then not all fund managers can do that,” he says.
For Sagitta, going to monthly redemption cycles will help to form closer ties with the 100 master trust platform providers the fund manager already has a relationship with.
While the change in a fund’s liquidity is directly impacted by the asset allocation of the fund managers, according to Hatfield, the role of research houses in influencing asset allocations means that much of the success of hedge funds being listed on master trusts remains in their hands.
Hatfield says if it were left up to efficient frontier theory to create an asset allocation, it would identify hedge funds as the investment class that should have the heaviest weighting due to their ability to respond to market movements proactively rather than reactively.
However, because such a strategy is not consistent with the fundamentals of diversification, fund managers apply constraints on what weightings they put on hedge funds. So while exposure to hedge funds can vary anywhere between five and 20 per cent, five to 10 per cent is the norm.
The other challenge with listing hedge funds on master trusts is defining what asset class hedge funds are a part of.
While they are often described as an equities tool due to their market-linked performance, Hatfield says hedge funds are more like an absolute return strategy. The fact that hedge funds have a negative correlation with the more traditional asset classes, further emphasises how this investment category is out on its own.
Hatfield says for this reason, it would be better to include an illiquid asset class that includes private equity, hedge funds and property into one category, that way properly defining the very nature of these investment groups.
BT Asset Management’s general manager for wrap services Mark Smith agrees. He says it is important to consider the way hedge funds are managed before they can be identified as such.
“Many hedge funds are not managed on geared ratios. And a true hedge fund is gearing beyond cash ratios,” he says.
Smith says hedge funds are getting listed on BT wrap products, but only when they get away from hedge funds and get down to the true nature of the portfolio. Due to this, BT spends more time reviewing hedge funds than any other type of product.
Sagitta’s Karrasch says another challenge for master trusts with listing hedge funds relates to a systems issue. If an investor needs money urgently and needs to cash out of a hedge fund, the transaction is dependent on the platform provider to be able to provide this service.
However, if people cannot access their money due to the lack of flexibility provided by hedge funds in realising this investment, the investor would ultimately blame the master trust rather than the fund manager. So it becomes a brand risk for platform providers to list hedge funds on their investment menus.
Karrasch also says the fee structure and rebating activity that is so integral to an adviser’s way of doing business, especially when attracting investors to less mainstream asset classes such as hedge funds, will be an important characteristic for master trusts to overcome.
However, not all master trusts will want to accommodate hedge funds.
Karrasch says some master trust providers may see it as a strength that they offer a standard set of investments at low cost with high levels of service, without having to introduce every new product developed by fund managers.
That said, given the declining performance of some of the more traditional asset classes, both investors and advisers will no doubt increasingly look to alternative asset classes that are negatively correlated.
