# Funds of hedge funds look to focus and diversify both at once

## Concentration on largest holdings has grown but average holding size has shrunk

In the past several years, the capital-raising/retention environment for commingled fund of hedge funds (FoHF) products has been difficult, and continued to be so into the end of 2015. FoHFs experienced outflows of $45.54 billion in 2015, representing 4.86% of the group's total assets under management (AUM) at the year's onset. Flows were only positive in Q2 ($2.57 billion) and most severely negative in Q4 (-$19.99 billion). Asset change due to performance was relatively mild compared with the change resulting from net flows. By the end of 2015, FoHF AUM stood at$889.01 billion. As a percentage of overall hedge fund AUM this represents 29.37%, the lowest level since eVestment began compiling asset information.

Pension funds have historically made up the bulk of FoHFs' investor asset base. At the end of Q3 2015, the average FoHF had an asset-weighted pension allocation level equivalent to 44.58% of its AUM. Allocations made by endowments/foundations – 16.79% of the average FoHF's AUM as of Q3 – and high-net-worth (HNW)/family offices (12.37%) were additional contributors of note to the multi-manager industry. Combined, these three investor types provide roughly 75 cents of every dollar within the average FoHF. However of these three investor types, only the percentage share contributed by endowments/foundations experienced a year-to-date, through Q3, increase of 1.28% compared with -1.71% by pension funds and -0.95% by HNW/family office. Relative investment in FoHFs by HNW/family office investors appears to be in a steady decline.

FoHF portfolios have become more concentrated over the years. The average number of underlying hedge funds within FoHF portfolios was relatively consistent from Q3 2012 onward, ranging from between 26 and 29 funds, whereas in preceding periods the average was 30 or more. The timing of this inflection coincides with the Greek government's default and increase in concerns about a possible ‘Grexit'.

Additionally, reported data indicates manager turnover has been increasing and the size of funds that FoHFs are investing in has been decreasing. The current weighted-average underlying hedge fund size is below the 2013-14 average and the average median underlying hedge fund size in FoHF portfolios declined noticeably from Q3 2014 and is also below its 2013-14 average. As of Q3, the average median underlying hedge fund in FoHF portfolios was $1.17 billion and the weighted-average underlying hedge fund$2.27 billion.

FoHFs have also increasingly positioned themselves around their largest holding. The average largest allocation to a single hedge fund manager by FoHFs was 11.25% as of Q3 2015. This represents the highest percentage since at least Q4 2011 and also a continuation of a gradual rise in the average over the years. The maximum percentage an individual FoHF allocated to a single manager hit 65% in Q2 2013, but since Q1 2014 the maximum has not even breached the 50% threshold. The minimum allocation by an individual FoHF remained extremely steady over the years, ranging between 3.20% and 3.65%.

By far the largest average multi-strategy FoHF portfolio exposure is to long/short equity strategies. Not once since at least Q4 2011 has this exposure level dipped below one-third of the portfolio and as of Q3 2015 the average underlying strategy exposure to long/short equity strategies was at 36.76%. The next largest exposure in Q3 was to event-driven multi-strategy (13.18%) followed by long/short credit (7.68%) and macro (7.42%) strategies. Exposure levels to macro and long/short equity strategies have been most volatile within FoHF portfolios. Figure 6 illustrates the 2015 (through Q3) shifts in multi-strategy FoHFs holdings by strategy.

Despite their overall decline as a portion of hedge fund assets, FoHFs are still major investors in the industry and their allocation decisions influence the overall distribution of assets. Trends such as increased concentration around the largest holding and decreasing underlying size of average investment indicate that while FoHFs are becoming more concentrated, the concentration is primarily around the top portion while allocations to smaller managers may be a concerted effort to distinguish their services by investing outside the proverbial box.

This report is based on characteristics and asset flows through December 2015 for 2,843 unique funds of hedge funds (FoHFs) sourced from the eVestment Global Database and eVestment private portals.

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