Aarnout Snouck of AXA Funds of Hedge Funds looks at the role and suitability of funds of hedge funds in the portfolios of retail and high net worth investors, and explains how advisers can distinguish various providers.
Date: Nov 2010
Tags: Hedge funds, Suitability, Diversification, Asset allocation, Liquidity
According to Aarnout Snouck in an interview, the role of funds of hedge funds (FoHFs) in a portfolio is one of diversification.
Hedge funds, and FoHFs specifically, give investors access to asset classes and assets which might otherwise be difficult for them to get exposure to, he explained, such as distressed debt or commodities.
In general, this leads to a broader toolkit, so rather than having to rely on the direction of the market, investors can potentially earn money when markets move in any direction.
Who is suitable for FoHFs
According to Snouck, the critical question when looking at which types of investors FoHFs are most suitable for is related to investment experience, rather than the amount someone can invest or an understanding of hedge funds
Those investors with the right experience don’t need to understand all the individual strategies, he explained, as that is the role of the fund manager and the banker.
Differentiating FoHF providers
When trying to differentiate the many FoHF providers who exist, Snouck pointed to some key things for bankers to look at.
For example, one thing which was poorly managed by a number of FoHFs during the crisis was the liquidity mismatch. FoHFs get a certain liquidity from the managers, and they give a certain amount to investors – typically better than they get from managers, he explained. So the FoHF therefore needs to manage this mismatch.
However, Snouck said they did this badly in many cases during the crisis, with a lot of FoHFs not being able to meet the redemptions they were facing since they couldn’t raise the money by redeeming out of their managers.
In addition to looking at liquidity and ensuring it is there when needed, bankers should also look at the investor base of the FoHFs, he added.
The crisis clearly showed that some investors take a longer-term approach than others. For instance, said Snouck, a lot of private banks tried to redeem out of FoHFs quite quickly. At the same time, banks which had bought guaranteed notes linked to FoHFs reduced their exposure to the asset class.
So analysing the investor base will help determine the stability of the individual FoHF, he said, and whether people should look for a more liquid portfolio.
Further, he added, the FoHF industry is a people business, so advisers need to be comfortable with individual managers and their background.
Snouck said he believes that only people who have been traders can ask the appropriate questions, understand the answers, and then determine whether a manager is actually implementing what they say.
Investment philosophy
Given that it was difficult before the crisis for FoHFs to distinguish themselves by anything other than outperformance, Snouck said a lot of funds were very directional, they levered that up and they became illiquid to generate higher returns.
As a result, when the crisis hit, these managers suffered badly.
So looking at the risk which a manager is taking to try to achieve the performance target is an essential part of assessing FoHFs, advised Snouck.
Developing the industry in Asia?
According to Snouck, building the understanding of FoHFs and explaining to investors what the industry can offer and how performance is generated is critical to developing FoHFs in Asia – especially in today’s market where there is an absence of people with a high conviction in specific markets.
