Sub-Advisor Funds of Hedge Funds: Sector in Brief

IN THIS PAPER

What are sub-advisor FoHFs? A new family of products; a less expensive alternative to FoHFs. Rather than investing directly into underlying hedge funds, the advisor collaborates with hedge fund managers who act as sub-advisors. Several large asset owners have developed similar structures in-house. This note outlines product features, target returns, expected equity beta and fees.

Benefits and drawbacks: Pros include a single layer of fees, a transparent managed account structure and UCITS compatibility; cons include hedge fund non-participation and opacity on how the underlying economics are shared.

Who’s investing? Asset owners seeking liquid, diversified, multi-strategy hedge fund exposure in a commingled fund format. UCITS compliance creates a bias towards a European investor basis, while the commingled structure enables smaller allocation sizes from small-to-mid-sized institutional investors and family offices.

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Last year saw major industry names launching the first commercially available ‘sub-advisor fund of hedge funds’; 2017 has brought the first allocations by bfinance clients.

The main benefit is significantly lower cost than a traditional fund of hedge funds (FoHF). Rather than investing directly into underlying hedge funds, the investment advisor collaborates with a range of hedge fund managers who act as sub-advisors for investments in a dedicated capital sleeve. The provider can offer a single layer fee structure, sharing out the economics behind the scenes. For European markets, these are generally offered as UCITS-compliant funds (the focus of this note).

We expect to see increased asset owner attention and more manager offerings for this model. Yet there is a comparatively high barrier to manager entry in terms of infrastructure and leveraging hedge fund relationships, which favours larger asset managers.

Although there is no expectation that the sub-advisor model could replace the traditional FoHF structure, it does bring new breadth to the market, which we view as a positive development. We also expect that the lower costs will drive further fee compression in the FoHF sector, where fees have already fallen by 20% in recent years according to bfinance data.