There are billions of good reasons why hedge funds are preoccupied with institutional investors: their dollars. Consulting firm Casey, Quirk & Associates of Darien, Connecticut, projects that institutional capital invested in hedge funds will rise to $1 trillion in 2010, from $360 billion in 2006, and will account for half of global flows into hedge funds over that time.
Yet pension funds and other institutions remain relative newcomers compared with the high-net-worth investors to whom hedge funds have historically catered. Hedge fund market experts say that the institutional inflows have turned an old 80-20 rule on its head: The wealthy, who were 80 percent of hedge funds’ clientele in 1999, are now closer to 20 percent. “High-net-worth investors are getting squeezed out,” says Paul Weisenfeld, chief operating officer of Citi Global Wealth Management Alternative Investments, which combines activities of Citigroup units Smith Barney and Citi Private Bank. “With [investment] minimums easily reaching $10 million or more, hedge fund managers can deal with fewer clients, save on administration and get sticky money.”
But wealthy customers aren’t accepting second-class status lying down, and advisers are devising ways to preserve their access to preferred hedge funds. These approaches include bundling multiple clients’ investments together, negotiating side deals with individual hedge funds, seeding new funds and assembling networks of funds into a platform providing a range of investor choices.
Citi, which has $40 billion in private-client alternative investments, offers several ways around minimum-investment restrictions. One, says Weisenfeld, is to hire a third-party or affiliated administrator, an accountant and lawyers to set up a feeder fund, which aggregates client assets and channels them directly into a hedge fund that in turn services just one client, Citi. “We often attack both the minimum and the client-service challenges with a feeder fund,” he explains.
RegentAtlantic, a $1.8 billion adviser, has moved to feeder funds because “any hedge fund manager who is good will increase its minimums, putting [the fund] out of reach of all but the biggest institutions,” says CIO Chris Cordero. The Chatham, New Jersey, firm is looking to extend the feeder approach to other alternative assets, such as timber.
Citi also strikes side agreements with managers. “We find high-quality managers and negotiate capacity and lower minimums so our clients can invest directly,” says Weisenfeld.
Robert Birnbaum, president and chief operating officer of $500 million global macro manager Third Wave Global Investors in Greenwich, Connecticut, says the firm rarely deals directly with individuals but is getting an increasing flow of business from brokerage-built platforms that serve them. Birnbaum wouldn’t reveal which platforms Third Wave is dealing with, but an example of this approach is Merrill Lynch & Co.’s HedgeAccess, which, in a variation on feeder funds, is an omnibus program for bundling clients’ money. “We hear from people all the time who may have read or heard about us, but in many ways, they aren’t equipped to deal with a complex strategy,” says Birnbaum. “They don’t have the experience or analytical tools to make an informed decision.” Hence they are helped by the platforms.
Leo Grohowski, CIO of BNY Mellon Wealth Management, says that the Bank of New York Mellon Corp. unit has been able to serve high-net-worth investors by pooling capital; through wholly owned funds of funds Ivy Asset Management Corp. of Jericho, New York and EACM Advisors of Norwalk, Connecticut; and through 15 percent–owned Optima Fund Management, a New York firm with fund-of-funds and single-manager programs. “That gives us flexibility,” says Grohowski.
He notes that institutionalization has a downside for hedge funds: Having a larger number of individual clients lowers the risk that one investor could significantly disrupt the fund with sizable inflows and outflows. Individuals also have the flexibility to take risks and make decisions without having to get approvals from boards of trustees.
“Institutions can move the needle quickly, and their concentration can give them bargaining clout and put downward pressure on fees,” says Jessica Drislane, director of hedge fund strategies at BNY Mellon.
