By Rachael Levy
A new round of warnings and redemptions from institutional investors underscores some of the pressure hedge funds face as the industry comes off one of its worst performance years on record. The rough spots have involved firms facing challenges such as lost assets, organizational changes, and performance blips.
Last month, hedge fund of funds Aurora Investment Management lost a big investor, a $488 million mandate from the $32.9 billion Illinois Municipal Retirement Fund, a year after the pension put Aurora on watch. Aurora had been part of the pension’s minority and womenowned funds program, according to documents on the pension’s website.
Though Aurora beat the pension’s benchmark, the retirement plan terminated the manager, citing its declining assets under management and personnel changes, according to a spokesman.
Like many hedge fund of funds firms – many facing blowback for the extra layer of fees they charge – Chicago based Aurora has seen its assets drop. The firm managed $5.5 billion as of Feb. 1, down from more than $10 billion it managed in 2013.
The outfit will soon go through more significant changes, with Northern Trust’s 50 South Capital Advisors announcing last week it would buy Aurora from longtime owner Natixis Global Asset Management.
EnTrust Permal, another hedge fund of funds going through an organizational shift, also is facing investor scrutiny. The Massachusetts Water Resources Authority Employees’ Retirement System placed the newly merged hedge fund of funds firm on watch, citing a consultant’s concerns about the organizational changes, according to MandateWire. Legg Mason, the parent company of Permal Group and EnTrust, combined the two companies earlier this year. Entrust Permal declined to comment.
Meanwhile, performance issues also put another hedge fund on watch by Cliffwater recently: The investment consultant added Luxor Capital Group to its watch list after the manager’s flagship hedge fund tumbled 19.2% last year, as reported.
At least one small investor also has pulled its investment in Luxor, citing underperformance. The investor, the $583 million Clemson University Foundation, recently pulled a $3 million investment, according to a source familiar with the matter and MandateWire. Overall outflows, however, are in line with previous years, according to the source.
The changes come as Luxor has offered new incentives to investors, dropping its management fees by a quarter and offering existing investors the option to add capital at current high watermark levels. Luxor is one of a handful of hedge funds offering such perks.
Being named on a consultant’s watchlist or facing redemptions aren’t necessarily big problems for a manager, says Andrew Saunders, a senior managing director at Castle Hill Partners, an institutional marketing and brokerage services advisor. The key is for hedge fund managers to communicate clearly with their investors, he says.
“Being put on watch is almost an automatic thing,”when there are structural changes at a firm, Saunders says. “If there’s a strategic rationale, and you can identify and ameliorate any issues or concerns, then you’re on top of it. It’s not necessarily that they are going to redeem because you sold your firm.”
Still, managers must show investors that their relationship remains stable, Saunders says.
“They need to reassure [investors] that whatever they bought is the same thing or close to it,” he adds. “If it’s changed significantly, they need to reset [investor] expectations.”
A good benchmark for managers is to consider any change from the investor’s perspective, Saunders says.
“Understand that [the investor] has to explain your performance or your situation to either their board or their boss,” he adds. “That should guide your interaction and outreach with them.”
Hedge managers especially should be honest about their mistakes, and show their progress in correcting any issues, said Jeff Kowalczyk, a consultant at Lowery Asset Consulting, during a panel at last month’s Alternative Investment Consultants Summit in Greenwich, Conn.
In some recent cases, underperforming hedge funds have offered fee reductions or high watermark perks, including David Einhorn’s Greenlight and Fir Tree Partners.
And while such incentives can support an investor relationship, they alone won’t keep investors loyal, says David Frank, CEO of third party marketer Stonehaven.
“Investors will not remain invested in a fund due to a fee reduction if they have lost confidence in a manager’s ability to produce compelling risk adjusted returns with low correlation,” Frank says. “The primary way for managers to retain capital is through consistent, proactive written and verbal communication followed by strong execution.”