It’s not just 2018. It’s been a rough several years for the hedge fund industry, said Jeff Blazek, head of investment firm Cambridge Associates’ healthcare practice. Among his health system clients, hedge fund investment is flat if not declining, he said.
Generally speaking, hedge funds are private investment partnerships that seek to achieve benchmark-beating returns, known as alpha, that are independent of market swings, and charge 1% to 2% of assets as a management fee and also keep up to 20% of any profits.
“I think the vast majority of investors would say that the hedge fund asset class as a whole has not provided the type of alpha that they would have hoped for,” Blazek said.
When health system investment committees see the high fees tacked on to hedge funds and their low single-digit returns compared with the S&P 500’s 9% returns, members tend to raise questions, Blazek said, adding he was involved in such conversations when he worked on New York-Presbyterian’s investment team. “It can be a lightning rod,” he said.
But a few health system investment leaders interviewed for this article stand by their allocation strategies.
At Advocate Aurora Health, the team gauges its hedge fund performance by comparing it to yields on fixed-income securities, a type of investment the health system replaced with hedge funds years ago when yields declined, said Dominic Nakis, Advocate Aurora’s chief financial officer. The system’s hedge fund portfolio has outperformed the fixed-income sector by 1.25 to 1.5 percentage points annually as determined by analyses looking at three- and five-year time periods, he said. And that’s with similar amounts of volatility.
Advocate Aurora’s hedge fund investments are less tied to the stock market than others, and the investment team takes a long-term view of their performance. “Having volatility from quarter to quarter is not something that concerns us on a daily basis,” Nakis said. “We really have structured our asset allocation program with a view of achieving a return over longer time periods.”
Southfield, Mich.-based Beaumont Health, which has nearly 20% of its investment assets in hedge funds, has a similar strategy to Advocate Aurora in that 75% of its hedge fund investments are not tied to the equity market, said Robert Kowalski, director of investments with Beaumont Health.
One mistake health systems can sometimes make is forecasting high alpha and also investing in a fashion meant to reduce their risk, or equity exposure, Blazek said.
“With low risk comes low return, and that’s just reality,” Blazek said. “It’s going to be very difficult to have a high single-digit return if you’re running a very low-risk hedge fund portfolio.”
A health system has to grow a fair amount just to be able to invest in hedge funds, many of which have minimum investment thresholds.
Mergers and consolidations multiply the amount of money they can invest and the sophistication at which they can do so.
Advocate Aurora’s hedge fund portfolio has grown slowly, at a rate of about 5% annually, over the past decade, Nakis said. As the system got bigger, more investment opportunities opened up.
“We’ve generally been more evolution versus revolution,” he said.
The same is true for Beaumont, which found itself in a much better position to invest and take on more illiquidity following the 2014 merger between Beaumont, Dearborn, Mich.-based Oakwood Healthcare and Botsford Hospital in Farmington Hills, Mich., Kowalski said.
Despite some investors’ dissatisfaction with hedge funds, the majority plan to increase their allocations over the long term, which is a noticeable turnaround from sentiments over the previous three years, Preqin found.
Globally, assets under hedge fund management reached $3.62 trillion at the end of the third quarter of 2018, but fell to $3.53 trillion as of November. Despite that, Preqin still predicts the industry will grow to $4.7 trillion by 2023.
For his part, Blazek believes hedge funds are in a consolidation phase, with smaller, less successful funds closing and more successful funds raising even more assets. There may be a margin increase in allocations, but nothing like in the 2000s.
“I would not say that we expect robust growth,” he said. “I think the growth is going to be pretty moderate, if there is any.”
