Disappointed by the returns from hedge funds, many family offices are turning to smaller players and more niche strategies

11 Jan. 2017 2:41 p.m. GMT | Original article on fnlondon.com

When Antonios Kypreos started investing on behalf of his father’s estate in 2005, it didn’t have enough money to meet the minimum investment tickets that big hedge funds asked for. These days, it has the money to invest with those larger funds – but no longer the motive.

“We find a lot of times that when people get too much money to manage, the quality goes down,” said Kypreos, a partner at Axion Single Family Office. “It’s typically managers that are [managing] $1 billion and below that have the real edge. They aren’t able to take money from the pension and sovereign wealth funds.”

That lack of interest in larger funds is a sentiment felt by many executives at family offices, which manage the money of rich families, ranging in size from one man bands up to organisations with dozens of staff that manage billions of dollars in perpetuity.

Factors including disappointment with the muted returns of many hedge funds over the past two years mean some are retraining their focus on smaller managers or opting for cheaper alternatives to hedge funds. In the most recent Global Family Office report from by UBS and Campden Wealth, published in September, a third of the 242 family offices surveyed planned to reduce their hedge fund allocation. On average, the study found, family offices had cut their hedge fund allocation to 8% from 9% between 2015 and 2016.

Philip Higson, vice chairman of the global family office group at UBS, attributes this drop to the lacklustre performance of many hedge funds over recent years, particularly when compared to lower cost funds.

“People saw quite good returns without doing very much from some of their very cheap index exposure,” Higson said. “I think [family offices] were a bit unimpressed with the relatively low return profile of their hedge funds.”

However, there appears to be growing interest from family offices to invest with smaller managers and new hedge funds. Research from HFR in December found that although the total number of hedge funds is declining, smaller managers are attracting more investor capital, suggesting that “investors are becoming more comfortable and willing to allocate to innovative, emerging managers as a complement to more established holdings”.

Karim Leguel, head of client strategy for Europe, the Middle East and Africa at JP Morgan Alternative Asset Management, said that over the past year he has seen an increase in interest from ultra high net worth individuals and family offices in investing in niche hedge fund strategies, particularly firms that have assets under management of less than $500 million.

“We have seen more interest in having more exposure to newer managers and niche strategies,” Leguel said, adding that such funds can provide “a bit more alpha” at a cheaper cost and also tended to offer returns that were not correlated to wider markets. That means greater diversification than some larger hedge funds offer. “I think the benefits are not just performance,” Leguel said.

Not all family offices have the time or expertise to carry out due diligence on smaller hedge funds. UBS’s Higson said he had seen his family office clients increasingly opting to use multi-strategy managers, which allow an investor to commit to a number of smaller or emerging managers through one fund.

“We’ve had a lot of success with some of the multi-strategy managers,” Higson said. “Our clients are letting the multi-strategy fund platform manager do the homework on the up-and-coming managers… so we’ve indirectly been funding emerging managers.”
For hedge fund Devet Capital, targeting family offices and rich individuals was a natural choice when it was set up in 2015. The London-based firm collected £40 million for its macro strategy in 2016, evidence that such investors are keen on newer managers, according to co-founder Leonardo Marroni.

“Last year was a tough year for the industry as a whole in terms of overall performance and also the performance of the big names,” Marroni said. But he noted that Devet received “a lot of interest” and “some decent inflows” from family offices. “Considering how bad the year was for the industry,” he added, “it was a good result”.

Some family offices are not just committing to new managers, but are becoming their first investor in exchange for a slice of the new hedge fund firm’s management company.

Dan Farrell, New York-based chief executive of Privos Capital, said that his multi-family office was keen to seed new funds and then use its own network to help them increase assets under management.

“We are increasing our allocations to hedge funds this year despite the negative noise we all hear in the market,” Farrell said. “The best trade in today’s market for a family office looking to play in the hedge fund space is to seed an ‘old manager’ who has the guts to walk away from their established huge fund and its corporate Gulf stream and start his or her own hedge fund.”

Farrell added that consultants and larger investors were “slamming the door” on new hedge funds, creating “huge opportunities” for family offices.

Family offices may also opt to boost returns by going for cheaper products, such as alternative beta or index funds. Oliver Druce, head of capital introductions for Europe at Societe Generale, said: “If you are looking at a small family office that is very fee sensitive and has perhaps been disappointed by performance then they are going to be more attuned and looking at alternative beta or cheaper fee strategies.”

Druce added that family offices are getting savvier with how they invest in hedge funds and were regularly “reviewing and reallocating how they invest”.

Back at Axion Single Family Office, Kypreos sums up how many in family offices seem to be feeling – and where they want to put their money.

“What we have realised is that there are over 13,000 hedge funds in the US, [and] a lot of them to be honest don’t really offer much difference than say a leveraged stock market ETF,” he said. “But there are a small group of funds that are investing in more esoteric markets that are giving people access to things that are uncorrelated to the markets. That is the space we like to be in.”