Institutions Remain Committed To Hedge Fund Investments, Despite Falling Returns
( Greenwich Associates )
(June 26, 2008)
Thursday, June 26, 2008 Stamford, CT USA - Last year's downturn in hedge fund performance has not caused institutions to shift their thinking with regard to their hedge fund investments, according to the latest research from Greenwich Associates and Global Custodian.
The share of hedge fund capital provided by institutions was unchanged from 2006 to 2007 following several years of steady growth. Nevertheless, the results of the 2008 Greenwich Associates/Global Custodian study suggest that pension funds, endowments and foundations remain strongly committed to the asset class.
Pensions and endowments/foundations directly provide 13% of the average hedge fund's assets under management. Institutions also commit assets to hedge funds through their investments in fund of funds, which account for an additional 23% of hedge fund assets. "High-net-worth individuals and family offices remain the biggest sources of assets for the average hedge fund, accounting for 37% of the total, which does not include about 10% of assets provided by the funds' employees and general partners," says Greenwich Associates consultant John Feng.
For the world's biggest hedge funds, however, institutional investors have overtaken high-net worth (HNW) individuals and family offices as a source of assets. Twenty-five percent of these funds' assets come from direct investments by institutions, while HNW/family office investment account for 22% of assets. "In terms of importance to funds with more than $1 billion in assets, both of these sources rank behind fund of funds, which provide 27% of total assets, up from 25% a year ago," says Greenwich Associates consultant John Colon.
A New Model for Portfolio Management
Institutions' commitment to hedge funds is due in large part to the key role that hedge funds have taken on in sophisticated portfolio management models that were first developed by endowments and foundations and are now being adopted by pension funds. These new models were designed to expand the principals of modern portfolio theory to encompass "non-traditional" assets. The approach is characterized most obviously by its heavy use of hedge funds, private equity funds, and, increasingly, other alternative asset classes viewed as having a low level of correlation with traditional fixed-income and equity holdings.
In the United States, which accounts for the vast majority of global institutional hedge fund investment, nearly 45% of institutions invest in hedge funds, which had grown to represent 2.6% of institutional assets as of 2007- up from 2.2% in 2006 and 1.9% in 2005. Although those percentages seem modest, when converted to dollar terms U.S. institutions' investments in hedge funds totaled some $195 billion in 2007, up from $140 billion in 2006 and $113 billion in 2005.
When asked about their hedge fund investments by Greenwich Associates in October 2007, 23% of U.S. institutions said they planned to increase their allocations beyond current levels by 2010; only 2% said they planned to reduce them. "It is important to keep in mind that average allocations at the country level include many institutions that do not invest in hedge funds at all," says John Feng. "Many active hedge fund users have devoted much larger shares of their assets. For example, U.S. endowments that describe themselves as active hedge fund investors devote on average 16.5% of their total assets to hedge fund investments."
Institutional interest in hedge funds received an additional boost from new hedge fund-style investment strategies that have been rolled out by both hedge fund managers and traditional asset management organizations looking to attract institutional dollars. Among the largest hedge funds participating in the 2008 Greenwich Associates/Global Custodian study, for example, nearly 11% say they are active in 130/30 strategies. "Hedge fund managers are creating new funds in which they dial down leverage and shorting activity to attract institutional investors, and they are also creating funds featuring their best long-only investment ideas," says Greenwich Associates Hedge Fund Specialist Karan Sampson. "On the other hand, traditional asset-management organizations are adding hedge-fund like products to get to the same place from the opposite direction."
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Greenwich Associates is the leading international research-based consulting firm in institutional financial services. Greenwich's studies provide benefits to the buyers and sellers of financial services in the form of benchmark information on best practices and market intelligence on overall trends. Based in Stamford, Connecticut, with additional offices in London, Toronto, Tokyo, and Singapore, the firm offers over 100 research-based consulting programs to more than 250 global financial-services companies. Please contact us for further information or to arrange an interview with one of our consultants. You can visit our website, www.greenwich.com, for more information.