Allocators and hedge fund managers aren’t exactly aligned when it comes to investment priorities.
In a survey of 79 hedge fund managers and 91 investors, SEI found that hedge fund managers and limited partners place different weights on various factors of the investment process, such as volatility, leverage, liquidity risk, exit strategy, and portfolio transparency.
The survey and the accompanying report was a product of a collaboration with ANZU Research, Preqin, and Global Fund Media.
When LPs and GPs were asked about the importance of low volatility, 36 percent of surveyed investors considered it a very important objective. Meanwhile, only 13 percent of GPs saw decreasing volatility as a key objective.
Ross Ellis, SEI’s vice president of thought leadership, said this dissonance is a result of managers taking the “long view.”
“In the hedge fund world, managers are saying, ‘We take the long view. Our job is to give you high alpha, good performance, and with that, comes volatility. And, in fact, volatility is our friend because we can make money if the market goes up, goes down, or stays the same,’” Ellis told Institutional Investor.
Limited partners, meanwhile, want to control their portfolio and ask GPs for certainty — an impossible request, Ellis said. To mitigate the anxiety, he said managers need to educate investors and potential clients about the ups and downs of the investment process.
“You need to give them more details about their expectations,” he said.
Volatility isn’t the only subject of misalignment between LPs and GPs. The survey also asked respondents to to identify major investor concerns around hedge fund investing and rate them on a 5-point scale. On issues like ongoing liquidity risk, leverage, lack of portfolio transparency, and lack of manager access, the percentage of managers who identified these as primary concerns lagged the proportion of investors who were concerned about these issues.
For example, while nearly 50 percent of LPs said leverage was a major concern for them, only about 20 percent of GPs said the same.
“The concern is not that leverage exists, it’s that the investor has no control over the amount of leverage being done by the manager,” Ellis said.
Managers also trailed investors when it came to concerns around portfolio transparency. Ellis said this is a long-standing issue between managers and allocators: Allocators wan more insight into the investment process.
Broadly, Ellis said the lack of alignment is a product of the dynamic between allocators and managers: LPs make a demand, and GPs react. But by the time GPs react, LPs have already shifted their goals or become more critical as markets shift.
“It’s like Newton’s cradle,” Ellis said.
However, as managers stretch their capabilities to meet the demands of their investors, Ellis said the hedge fund market only becomes more sophisticated.
“The lack of alignment is always going to be there,” he said. “It’s the nature of the growing sophistication of the market… there’s always going to be something.”