Hedge Fund Allocations

We are starting to see a new methodology in the area of Hedge Fund Allocations. Fund of Funds and Institutional Investors are going back to the drawing board and re-evaluating the way they make their allocations. We not only saw a meltdown in the stock market, we also saw a number of high-profile frauds, such as the Madoff Ponzi Scheme and Bayou Hedge Fund to name a few. These frauds also dealt a serious blow to the hedge fund arena.

Investors need to have a better way of performing due diligence, rather than just a check the box mentality. In a previous article, I talked about the formation of an Investment Company Accounting Oversight Board (ICAOB), similar to the Public Company Accounting Oversight Board (PCAOB) that oversees CPA firms that perform audits on public companies. In the Madoff and Bayou situation, they were using unknown firms to prepare their financial statements, which was a big part of the problem. The institution of an ICAOB would be a welcome addition to some of the regulations already in place.

We are now starting to see institutions, fund of funds and pensions making smaller hedge fund allocations to a larger number of fund managers for risk diversification, as well as investment diversification. In the past, large allocations to just a few managers have resulted in large losses to investors; this is what is now being referred to as the Hedge Fund Armada Syndrome. Smaller more nimble funds can move positions more rapidly and have proven over time to outperform the larger funds.

We are likely to see investors re-thinking and making allocations to smaller funds as a result of risk and investment diversification. In the meantime, Hedge Fund Allocationsare likely going to wait on the sidelines as investors re-evaluate their methodology and look for signs of a market recovery.