DETROIT — Despite being associated with one of the largest
hedge fund implosions in recent memory, the multistrategy
hedge fund model continues to represent the gold standard for much of the $1.2 trillion industry.
It was just six months ago that Greenwich, Conn.-based multistrategy fund Amaranth Advisors LLC, worth $9.2 billion at its peak, lost $6.6 billion due to a lopsided weighting in natural-gas investments.
Although the multistrategy model could be uniquely vulnerable to the kinds of risks that ultimately brought down the Amaranth fund, it continues to gain converts across the alternative-investments community, some industry analysts say.
“It’s a natural evolution, and it’s driven by the demands of investors,” said Meredith Jones, director of market research at Strategic Financial Solutions LLC in Reno, Nev.
The multistrategy model typically involves a single management firm providing access through a single
hedge fund to a broad range of underlying strategies. Just like Amaranth, the overall manager has the flexibility to allocate a fund’s capital to the underlying strategies that appear to present the greatest opportunities.
“As an industry, we realize some strategies are good at certain times and not at others,” said Damian Handzy, chief executive of Investor Analytics LLC. The New York-based firm provides quantitative risk analysis for multistrategy hedge funds and funds of hedge funds.
“As a
hedge fund strategy, you need to be nimble,” Mr. Handzy added. “Therefore, the right thing to do is discretionary and be opportunistic and be multistrategy.”
Unlike a fund of hedge funds, a multistrategy fund tends to rely exclusively on in-house expertise to manage the various underlying strategies, which introduces both part of the appeal and part of the added risk associated with the model.
“People want a single minimum investment in a portfolio that theoretically should be able to benefit in all market conditions,” Ms. Jones said.
Upscale clients
In some respects, the popularity of multistrategy hedge funds represents the evolution of a more sophisticated and savvy investor base, according to Charles Gradante, managing principal at Hennessee Hedge Fund Advisory Group LLC in New York.
“Now that institutional investors have gotten three- to five-years’ worth of experience with funds of [hedge] funds, they’re more seasoned and more courageous, and they’re more likely to go to multistrategy funds,” he said.
As the appetite increases for the best hedge fund managers, some money managers are adopting the multistrategy model as a way to put the inflows to work, according to Robert Levitt, a financial adviser and president of Levitt Capital Management LLC in Boca Raton, Fla.
“The bigger you get, the more attractive you become,” he said. “The reality is, the bigger funds can’t manage all the money in one strategy, and that drives the multistrategy model.”
Mr. Gradante agrees, comparing the growth of the model to a chicken-and-egg scenario.
“If investors like a hedge fund as a single manager, they like it even more as a multistrategy, because their money is spread across more strategies,” he said.
In terms of performance, multistrategy funds have an advantage right off the blocks over funds of funds in that they don’t come with the added layer of management and performance fees typically associated with funds of funds.
“Institutions like the multistrategy funds because they’re cheaper than funds of funds,” Mr. Gradante added. “The extra layer of fees is pretty significant, and I would imagine multistrategy funds should outperform over the long term, but the jury is still out on that.”
According to Morningstar Inc. of Chicago, multistrategy funds on average have outperformed funds of hedge funds over the past 10-, five- and three-year periods. The Morningstar database includes 662 multistrategy funds with $220.8 billion under management, and 1,964 funds of funds with $642.3 billion in total assets.
Through February, multistrategy funds averaged a 10-year annualized return of 10.1%, compared with 9.1% for funds of funds. The five-year annualized data shows multistrategy funds outperforming, 10.1% to 8.5%. The three-year annualized data favors multistrategy funds, 9.0% to 8.4%.
Outperforms funds of funds
For the 12 months through February, multistrategy funds averaged a 10.2% gain, while funds of funds in the database produced an average gain of 8.9%. “By and large, funds of funds and multistrategy funds all act like balanced portfolios, and their returns tend to mirror one another,” said Ryan Tagal, Morningstar’s director of hedge funds and alternative investments.
“The problem with a multistrategy fund is that you could still have an Amaranth scenario, where everything is under one roof and one style could dominate and blow up the whole thing,” he said. “More so than ever, because all the expertise is in one place, the investor needs to check it out and make sure there are safeguards in place.”
The operational risks associated with the multistrategy model is just one of the reasons to proceed with caution, according to Virginia Parker, president of Parker Global Strategies LLC, a Stamford, Conn.-based funds of funds manager with $1 billion under advisement. “We believe most multistrategy funds are mediocre, because it is very rare for a firm to have the best management team in each area,” she said.
As opposed to providing ac-cess to some of the most sought-after money managers — which often is an advantage of a fund of funds — Ms. Parker said that the multistrategy manager is forced to use whatever resources are available in-house to achieve a certain allocation.
“We don’t believe you can get from a multistrategy manager the same things you can get from a fund of funds,” she said. “And that’s how you end up with a lot of manager risk.”
