In a year hedge funds were unable to
deliver the absolute returns they promise and with clients becoming
increasingly frustrated, private banks are looking at new ways of
adding value. One of the options is investing in fund of funds, but
even they are not without their drawbacks.

Private Banker
International’s most recent survey does not make comfortable
reading for hedge fund managers. It revealed a majority of private
bankers believe the number of hedge funds will have halved by the
end of the current crisis. And it is not the first prediction of
demise for the industry – the most leveraged of them all – in a
financial system most agree needs to reduce its gearing.

Estimates within the hedge fund industry are not as bleak, but
still make sobering reading. Thomas Della Casa, head of research,
analysis and strategy risk at Man Group, the industry’s largest
listed fund manager, estimates a fifth of hedge fund managers could
go out of business in the next two years. That excludes the impacts
of consolidation expected to take place in an industry where
quality has been diluted with a rash of new fund openings.

Hedge fund assets have been reducing at a record rate, with
redemptions and performance losses combining to reduce the size of
the industry by $210 billion in the third quarter of 2008,
according to Hedge Fund Research (HFR) figures. At the end of the
third quarter, total industry capital stood at $1.72 trillion, down
from $1.93 trillion at the end of the second quarter, including $31
billion of redemptions. Once successful funds have seen previous
gains almost wiped out – the Switzerland-based 788 China fund, one
of the best performers last year, recorded a loss of 95 percent for
the first 10 months of 2008.

It is hardly surprising as investors, who believed hedge funds
could provide returns uncorrelated to the market, flock to cash.
And it is a theme Peter Clarke, chief executive of Man Group,
expects to continue into 2009.

He believes hedge fund assets will continue to slide in the
first quarter of next year, in a reversal of the dramatic inflows
in recent years. Other big players to have suffered include GLG and
RAB Capital, which have had their assets frozen by administrators
PricewaterhouseCoopers following the collapse of Lehman
Brothers.

Despite the flood of bad news, there remains evidence investors
are interested in hedge funds. Research from the Association of
Investment Companies, which surveyed 1,300 investors, found just 3
percent had current plans to invest in the funds, but 46 percent
said they would possibly be interested in the future. They also
voiced concerns about regulation and fees.

Fund of funds

Private banks are increasingly looking at fund of funds to
bridge the divide between the desire for access to hedge funds and
a reluctance to lock up capital for long periods, as the funds
would prefer. SG Hambros, the UK-based Société Générale (SocGen)
subsidiary, recently launched a product called Titan, a
multi-manager, multi-strategy fund which allows weekly
liquidity.

It operates on Lyxor, a managed account platform wholly owned by
SocGen, which mitigates the operational risk associated with hedge
funds. Andrew Popper, chief investment officer at SG Hambros,
admitted there were client concerns regarding the performance of
individual hedge funds, but said the fund of fund approach remained
in demand.

He said: “There remains interest from clients, but it depends on
the way we invest in hedge funds and that is why we are presenting
this range of investments on this platform rather than the
traditional products. There’s a deep interest in the fund-of-fund
approach and we have had significant amounts of new money come in
on the basis of this new Lyxor product.

“Our clients have not given up hope so far as the hedge fund
industry is concerned but they want the liquidity and control of
strategy and assets.”

However, David Maude, an independent wealth management
consultant, said there was a trade off between liquidity and
fees.