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Solved: The FoHF Selection Puzzle

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Stockholm (HedgeNordic) – There has long been the discussion of funds of funds facing the end of their days, with investors pondering on the question of whether funds of funds warrant their extra layer of fees. Yet, a select group of funds of hedge funds continues to thrive by delivering attractive risk-adjusted returns to their investors. Secure Spectrum’s Head of Hedge Funds, Jeppe Blirup (pictured), appears to have solved the fund selection puzzle by shaping a successful fund of funds strategy that is employed by Secure Hedge.

Originally launched in a fund structure in mid-2013, Secure Hedge has gone through a process of vision and strategy change after the appointment of Jeppe Blirup as portfolio manager. “When I took over the management of the fund in 2015, I slowly started diversifying the fund. I really believe in diversification across managers, strategies and geographies,” says Blirup. “We made a strategy shift towards building an absolute return fund, we started looking for new absolute return hedge funds operating in inefficient corners of the market,” he continues. “We have been spending all our time and energy on finding niche funds playing unfair fights in their favour.”

“We started looking for new absolute return hedge funds operating in inefficient corners of the market.”

Secure Hedge has built a diversified portfolio of about a dozen hedge funds employing “idiosyncratic and niche strategies” such as short activism, event-driven involving various types of arbitrage opportunities, opportunistic credit, among others. “Most of the hedge funds we invest in are niche and capacity constrained, engaging in those corners of the market where big players such as long-only managers or pension funds are not as active,” argues Blirup. “The focus on market inefficiency was the major change in our strategy.”

“Most of the hedge funds we invest in are niche and capacity constrained, engaging in those corners of the market where big players such as long-only managers or pension funds are not as active.”

The ideal candidates for inclusion in Secure Hedge’s portfolio are “multi-strategy platforms with lots of portfolio managers, with each portfolio manager focused on a niche part of the market.” A small team can focus on trading transmission rights, for instance, while others can focus on totally different corners of the market. “If we can find a manager that can diversify our exposure across many, many niche strategies, we will try to onboard that manager,” says Blirup. “You can build a robust return profile by adding up all these niche strategies at a platform level.” This focus on idiosyncrasy has started to bear fruits for Secure Hedge.

Secure Hedge has delivered a net-of-fees annualized return of eight percent over the three years through January this year to reach a three-year Sharpe ratio of 2.3. The fund of hedge funds experienced a maximum drawdown of only 2.7 percent over this period, which also included the turbulent first quarter of 2020. Secure Hedge gained a little over six percent in the Covid-stricken first quarter of 2020 and has been enjoying 18 consecutive months of positive returns.

Allocation

Secure Hedge has built a portfolio currently containing 16 hedge funds, four of which are in redemption phase. “We want to be in the funds that we really like by creating long-term partnerships,” says Jeppe Blirup, who leads asset allocation and oversight at the fund-of-funds level alongside portfolio manager Andreas Skov and investment analyst David Buhl. “It is a lot easier to be long-term partners with managers that are able to always get to first base in baseball lingo, managers that are playing it safe, grinding out alpha and delivering a decent return rather than the ones that take a lot of beta exposure.”

“It is a lot easier to be long-term partners with managers that are able to always get to first base in baseball lingo, managers that are playing it safe, grinding out alpha and delivering a decent return rather than the ones that take a lot of beta exposure.”

The team managing Secure Hedge is guided by an allocation framework that starts with a five percent allocation to a new fund. “We have about €100 million in assets under management, so we are happy to take that allocation up to double digits,” explains Blirup. At the moment, Secure Hedge has only one underlying fund that accounts for around ten percent of the overall portfolio, with allocations to the other funds falling between five and ten percent. Secure Hedge’s allocation to successful funds can, at times, exceed 20 percent.

“In the past five years, contrary to probably most allocators out there, we have been meaningfully invested in U.S. short activism,” says Blirup. “Short activism is a very niche area of global capital markets, as there are very few short activist funds.” One of the short activism funds Secure Hedge has been invested in delivered mid-teen to 20 percent in annual returns with no correlation to stock market development. At some point, Secure Hedge had 21 percent of its portfolio allocated to that fund. “As our assets under management grew, the allocation has come down because the fund was closed to new capital.”

Expectations

Secure Hedge has generated an annualized return of eight percent over the past 36 months, comfortably meeting its return target of six to nine percent. “We can deliver six to nine percent net over time. That is what we are aiming for,” says Blirup. “One of the reasons the fund has not delivered more than eight percent over the last three years in annual terms lies in the fact that we have been underinvested,” he emphasizes. With Secure Hedge exhibiting “really low volatility,” which is aimed to stay in the range of 2.5 percent to 4.5 percent, the team plans to enhance the fund’s return profile by employing leverage.

“We can deliver six to nine percent net over time. That is what we are aiming for.”

“We have now taken a credit facility and we plan to use it,” says Blirup. “We are only talking about using around 10 to 15 percent leverage,” he continues. “With the new funds that we have in the portfolio and with their return independence from the markets, I cannot see why we should not deliver six to nine percent over time.” Secure Hedge also aims to achieve its return target by exhibiting annual volatility of less than five percent.

“The fund’s return and volatility should fall within our targets over the next five years,” argues Blirup. “We may come in a little bit short in any given year,” he acknowledges, “especially in a world that really turns for the worst, which it might over the next several years with wars and inherently more volatility in the markets.” Even so, Secure Hedge has been able to withstand the turbulent market environment of the past few years, with the fund delivering 18 consecutive months of positive returns.

“I believe we have found the secret sauce for successful investing in hedge funds, which can enable Secure Hedge to perform in different market environments.”

“It goes without saying that this string cannot last forever, we will have down periods,” Blirup points out. “But I believe we have found the secret sauce for successful investing in hedge funds, which can enable Secure Hedge to perform in different market environments,” he adds. Secure Hedge has about 8,000 founds to choose from globally, and Blirup and his team only need to pick between ten and 20 successful niche managers to solve their fund selection puzzle.

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Eugeniu Guzun
Eugeniu Guzun
Eugeniu Guzun serves as a data analyst responsible for maintaining and gatekeeping the Nordic Hedge Index, and as a journalist covering the Nordic hedge fund industry for HedgeNordic. Eugeniu completed his Master’s degree at the Stockholm School of Economics in 2018. Write to Eugeniu Guzun at eugene@hedgenordic.com

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