LONDON (Dow Jones)--Funds of hedge funds are under threat as some of their biggest institutional clients move toward direct investing in hedge funds, speakers at a hedge fund conference said Wednesday.
The investment pools, which research, select and monitor hedge fund managers for flagship funds or customized portfolios, may either have to shift their focus to niche strategies or reduce their fees to continue to attract institutional investors, said participants at Edhec Hedge Fund Days, a two-day conference sponsored by French business school Edhec.
"The reasons to invest have changed. The emphasis on diversifying away idiosyncratic risk and to get hold of the skills of fund-of-hedge-fund managers has caused a fork in the road," said Ken Kinsey-Quick, head of multi-manager investments at Thames River Capital, a London-based investment firm.
"On the left hand you have institutional strategies that will be very commoditized. On the right fork, there will be very innovative individuals using new techniques and focused on finding new ideas," he said.
Those choosing the former path may have to reduce their fees, Kinsey-Quick said. Funds of funds typically charge a 1% management fee plus 10% of profits. Investors in these funds also absorb underlying hedge fund manager fees, usually 2% for management and 20% of profits.
Pim van Santen, investment manager for hedge funds at Shell Pensioenfonds Beheer BV, the pension fund of Royal Dutch Shell (RDSA), said institutions don't necessarily need funds of hedge funds for their research capabilities, one of the main reasons funds of hedge funds exist.
"You don't need to be a very large organization to invest directly in hedge funds running traditional strategies," he said.
And while funds of hedge funds often promote their ability to invest with top hedge fund managers whose funds sometimes are closed to other investors, van Santen said he instead has found that hedge funds are happy to get direct investments from pension funds.
Dan Lancellotti, global head of capital introductions for Citigroup Inc.'s (C) prime brokerage business, said he has also found this to be the case.
"It's getting more challenging for funds of funds to find good managers because pension funds and endowments are making the decision to invest directly," he said.
"Rarely does a hedge fund turn down money from a qualified investor. If you are one, it is likely you will get a seat at that hedge fund."