Investment consultants will launch funds of funds in time, Towers Watson says

25 Oct, 2012

It is highly probable some investment consultants will eventually launch funds of funds vehicles, Towers Watson has said.

Speaking at SEI’s annual COO and CFO conference in London earlier this month, Yodia Lo, investment consultant at Towers Watson, acknowledged the distinction between funds of funds and investment consultants was blurred, although added “investment consultants are typically not paid on performance and tend to have a more conservative investment approach given their client base.”

Towers Watson was recently given a £100 million mandate by the £1.5 billion Willis Pension Scheme. Towers Watson will manage the capital on a fiduciary basis in what appears to be a hybrid between an investment consultancy relationship and funds of funds.

Were a consultant to offer a funds of funds, it is believed the vehicle would not be too dissimilar to what is provided at most funds of funds. It would pool client assets rather than offer bespoke solutions, although experts reckon it would be substantially cheaper than the traditional funds of funds route. However, issues over conflicts of interest are almost certainly to arise.

The irony of consultants potentially launching funds of funds will not be lost on their critics. Consultants have been attracting investors who traditionally would have accessed single managers via funds of funds. Many consultants have indeed hired operational and investment due diligence executives from funds of funds in what some commentators predict is a precursor to consultants developing funds of funds businesses internally.

Lo highlighted the traditional model of funds of funds whereby managers charged 1 and 10 was not a sustainable one. “Consultants offer a better value proposition when it comes to manager access,” she said.

Stephen Oxley, managing director at PAAMCO, the $8.5 billion fund of funds, disputed this, saying a number of funds of funds have institutional fee structures while fees with underlying managers are negotiated properly so the total fees paid are similar to going directly to a single manager or via a consultant.

Investment consultants are also routinely accused of channelling money into the largest, brand name managers thereby delivering correlated returns for their underlying clients. Nevertheless, funds of funds' performance has been questionable. A report by S&P Capital IQ Fund Research said more than 90% of funds of funds would be “ungradable” if their performance had been measured against absolute as opposed to relative return benchmarks. Funds of funds' AuM has subsequently fallen as a result. Data from BarclayHedge reveals funds of funds’ Assets under Management (AuM) currently stands at $533 billion, down from its $1.2 trillion peak in 2007

“The funds of funds which will thrive today are the ones which perform extensive analysis and due diligence on emerging and niche managers to be able to provide customised exposures of the sort their clients can’t create themselves,” said Oxley.

Lo also acknowledged single managers had been given a black eye in 2011 while 2012’s returns have so far proved unspectacular. “The S&P made gains when absolute return managers made losses. The macro headwinds caught some of the smartest managers off guard and they got blown over. People ask whether 2012 is a make or break year for hedge funds. I believe it will be the smaller hedge funds – typified by three managers and a Bloomberg, which will go,” she said.

Many smaller managers, despite delivering better returns than their established counterparts, are struggling under the weight of regulation and diminished investor risk appetite.  Hedge funds have struggled to make decent returns since 2008 having recorded losses in two years out of four. The average hedge fund declined 5% in 2011 although the industry has recovered posting modest gains of 4.76% year-to-date (YTD) 2012, Hedge Fund Research data shows.

These lacklustre gains have prompted some investors to reassess their hedge fund exposures. Preqin data in summer 2012 revealed private sector pension plans had trimmed their hedge fund exposures to roughly 6% of their portfolios, down from 9% in 2008. Given the underperformance of other asset classes, there are question marks where these pension funds, many of whom have huge liabilities, will put their money to work.

“There are very few alternatives for pension funds to go to. The majority of pension funds and their trustees believe that long-only managers are less risky than hedge funds, which is not true. Hedge funds produce carefully risk-managed and risk controlled returns and they are a good match for pension funds,” said Jeroen Tielman, CEO at ImQubator (IMQ), the €250 million Amsterdam-based seeding platform backed by the Dutch pension plan APG.

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