For Registered Investment Advisers, Alternatives Go In-House

More and more, wealth management firms are including internal hedge fund strategies to bolster returns and lessen fees.

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Throughout the years, some large family offices have run actively managed portfolios internally. Notable examples include the family offices of two big-name tech entrepreneurs: Michael Dell’s MSD Capital and Bill Gates’s Cascade Investment. In 2011 legendary hedge fund manager George Soros gave back his clients’ funds, and today Soros Fund Management runs money exclusively for his family. For the most part, however, in the past the practice was far less common and rarely involved alternative strategies. Today that appears to be changing rapidly as the registered investment adviser community aggressively steps up recruitment efforts to bring buy-side talent in-house.

Larry Letterio, president of Altair Management Partners in Wexford, Pennsylvania, notes that selecting internal managers and external ones is a very similar process. “We have been tearing apart hedge fund portfolios for two decades,” he explains. “We’ve seen good ones and bad ones and learned the factors that will make it more likely that a manager will be successful.”

There is a reason why a firm focused on advising multigenerational wealth is the perfect place to launch new total return strategies, says Richard Zenker, a managing director of Overbrook Management Corp. in New York. “We have a universe of truly long-term investors,” says Zenker, a Wall Street veteran who prior to joining Overbrook in 2003 held senior positions at Thomas Weisel Partners and Royal Bank of Canada. “They aren’t looking for a smooth path as much as solid long-term returns.”

Overbrook, founded in 1946 by Frank Altschul, a former senior partner at Lazard Frères, for more than 50 years managed only the Altschul family investment portfolio and oversaw the family’s many philanthropic activities. Roughly a decade ago Overbrook decided to expand to a multifamily format and take in outside investors. Today the firm manages more than $700 million in assets, with a substantial additional amount under advisement. The firm brought on Andrew Goffe as CEO, CIO and president in late 2011 from the now closed O.S.S. Capital Management, a hedge fund firm he co-founded in 2001.

Overbrook is just one of many advisers that have started to seek internal active managers. “For the manager it’s enticing to skip the sales, marketing and regulatory headaches, while for the investor it’s a way to scale back fees,” says Richard Taglianetti, a managing director at New York’s Corinthian Partners. According to Taglianetti, there are roughly 3,500 family and multifamily offices in the U.S. that have $500 million or more in assets, a level he thinks is probably necessary to support a platform that can actively manage external capital.

The shift to managing strategies directly in-house has proved easier for some firms than for others. “As a business line it’s a leap, but from an investment standpoint it’s a logical evolution,” says Altair’s Letterio. Founded in 1992 with a focus on advising wealthy families, Altair initially developed an interest in running money in-house because of, in part, the high fees being charged by alternative managers. “During the lead-up to the financial crisis, we noticed that in the hedged equity space, where a 7 percent annualized return represents a good year, about 47 percent of all gross returns were going back to the manager in the form of base fee and carry,” notes Letterio.

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The firm took its first step into more scalable asset management in 2001 with the introduction of Altair Hedged Equity Partners, a multimanager hedge fund group. David Kamin, formerly of New York–headquartered, multibillion-dollar hedge fund firm Ramius, later joined Altair as co–portfolio manager for total return strategies. Kamin handles internally managed strategies, which are being presented in a separately managed account form to outside investors, including other advisers and institutions. To date, Altair’s two primary separately managed account products have outperformed their benchmarks.

The team at Overbrook also was concerned about the high fees being charged by alternative asset managers when constructing its in-house strategies. The firm’s new long-only equity fund does not charge incentive fees. At first glance, it might appear to be little more than a typical plain vanilla mutual fund. But with significant concentrations — the ten largest positions account for roughly 55 percent of the portfolio — as well as an all-cap mandate with an emphasis on companies in the $500 million to $10 billion range, the fund by design is really more of a long-short hedge fund without the shorts.

“I think that most managers, if they were honest, would admit that short-selling is more a justification for a fee structure than a good way to make money,” says Goffe. “Over time it’s a way of muting short-term volatility, but those structures ultimately destroy value through fees.” Since its inception at the beginning of 2013, the fund has outperformed the S&P 500 and Russell 2000.

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