Hedge Fund Selection : Not a one analyst show

Candriam has been an active player in Hedge Fund Selection for 20 years now. This activity started as a research function to feed the needs of its discretionary managed Fund of Hedge Funds to become a proven process and a pillar of fund management. This activity was then progressively expanded to propose its knowledge and research capabilities to the benefit of other Candriam business units, affiliated companies and institutional clients.

Currently, hedge fund selection supports investment activities weighing EUR 750 million in collective investment vehicles and discretionary institutional mandates and EUR 750 million in hedge fund advisory. Candriam believes alternative strategies are able to bring value to its clients’ portfolio either via an allocation to Fund of Hedge Funds or by identifying the right set of funds more appropriate to its clients’ mandates.

So, how does Candriam select Hedge Funds?

Candriam’s Hedge Fund selection effort will be driven by the objectives of picking investment strategies that are able to capture alpha in a repeatable and consistent manner, managed by talented investors within a robust and well-organized framework and, very importantly, adapted to the clients’ specific needs. Easy no? Well, allow me to disagree. As for many fund selectors, choosing a hedge fund strategy is the outcome of a lengthy process that will start by sourcing ideas from the analyst’s network or through a quantitative screening of the universe. The knowledge one can gather from an industry network built along years of professional experience is very valuable to find the best investment opportunities. The Hedge Fund Industry is an extremely competitive world where talent will find its way.

The most talented investment professionals will tend to build their careers across several firms and spin-off at an early stage to hang their own name on the door. Hence, you cannot only rely on quantitative screening to track the most promising investment professionals. Quantitative analysis are important to compare homogeneous groups of hedge fund strategies and understand the risk profile of your investments. Once a short-list of funds is defined, interviews and monitoring of the selected managers will be carried on during a time frame that can take up to several quarters to fully understand the investment strategy process and the quality of the investment team.

Finally, when a potential candidate is identified, a meticulous desk work analysis will start gathering the inputs from both Candriam’s Fund Selection and Risk Management teams after analyzing a thorough due diligence documentation package. This will include for a standard analysis legally required documents such as the fund’s offering memorandum and financial statements, the investment manager’s regulatory registrations and filings, the analysis of the company’s manuals and procedures for operations, an operational due diligence report written by Candriam’s Risk Management team, the investment letters and factsheets and a quantitative analysis of the fund identified and its peer group, to name a few. 

After this brief description of the fund selection process, I would like to highlight a few elements that are particularly important for Candriam’s Fund Selection Team and that differentiate us from other fund selection processes: 

Belief in a team effort approach and consensus decision process within fund selection

The Fund Selection team is a 10 analyst strong unit with extensive and varied backgrounds and professional experiences. We perceive diversity of thinking as an asset and although a consensus decision approach is favored, you need a team leader to take responsibility for the ultimate arbitrage.

Belief in a flexible fund selection approach articulated around a meticulous and rigorous fund selection framework

The Hedge Fund Universe is very heterogeneous and populated by an abundant number of niche strategies and smaller sized companies. This is a differentiating element towards Mutual Fund Selection where larger asset managers with more resources dominate the spectrum. More often than not, you will not be able to comfortably check all the boxes in your selection process.

Keep an open mind

Although large institutional asset managers have more resources to invest in staff and systems, hedge funds are often capacity constrained strategies. Hence, more nimble firms and strategies in terms of assets may be more adequate to generate alpha from market arbitrage and dislocations. Therefore, qualitative analysis is crucial to assess if the set up and operational structure is adequate to support the investment function.

The Fund Selection and Risk Management teams work side by side during the selection process

It is always good having a second pair of eyes challenge your views. The constant dialog between the team seldom leads to a blocking point but the Risk Management has a veto right during the selection process. 

To conclude, it is inevitable to discuss how the current pandemic will change the future of hedge fund selection. We think the current crisis will accelerate already existing trends rather than fundamentally change previous behaviors. Fund selectors will increase the utilization of video conference tools to keep contact and monitor existing managers and potential prospects, however, we still believe in the usefulness and necessity to meet in person a manager before a final investment decision.

Also, the necessity of adopting of social responsible investment principles will continue to make its way into the Hedge Fund world. This will require higher transparency standards from managers towards investors. Finally, considering current compressed levels of market premia, hedge funds will be further selected as an alternative to traditional strategies rather than as a complement or a diversifier to mutual funds.  Stay safe! 

About the Author - Natalino Barbosa, Senior Hedge Fund Analyst

Natalino has worked in the finance industry for 17 years and has been directly involved in fund selection for the last decade. Before moving to Candriam, he began his career as a performance and risk analyst at Schroders. He then joined Candriam’s Risk Management team where he monitored risk compliance of commingled Fund of Hedge Fund vehicles. He supported the investment process of these vehicles, performing operational due diligence for hedge funds before joining the investment team in 2010.

Natalino covers the liquid and illiquid hedge fund universe generating investment ideas for his team’s commingled fund and client-specific investment mandates. He is also responsible for coordinating Candriam’s team efforts to select Alternative UCITS strategies for a Buy-List that is proposed to internal and external clients.