By Todd Groome
Published: July 25 2010 09:16 | Last updated: July 25 2010 09:16
The perception has long been that those who invest in hedge funds are wealthy individuals – very wealthy. That was largely true when hedge funds began many years ago, but it is no longer the case. Today, investors in hedge funds are more likely to be institutions such as university endowments, charitable foundations, public and private sector pension funds and sovereign wealth funds.
This investor transformation has been a gradual process that reached a material milestone last year when, according to research by the Alternative Investment Management Association, institutions for the first time accounted for an absolute majority of hedge fund assets under management. Research has also shown that during much of the past 10 years, institutional investors represented the majority of net new investment capital in the industry.
Such institutional interest is evident among smaller hedge managers and many institutional investors are early stage investors with smaller funds, even start-ups.
Of capital from institutions, Aima’s research suggests that about one-third comes from pensions. Pension managers say their interest in hedge funds is driven by expectations of higher quality returns as well as additional risk management expertise and trading or market nimbleness – attributes valued in recent volatile markets. From a macro perspective, advanced economies across the world are facing demographic pressures, and the funding positions of many pensions are challenged. Hedge funds are viewed as offering better risk-adjusted returns than other asset classes.
Pension funds globally typically allocated less than 5 per cent of their portfolio to hedge funds or funds of hedge funds (while targeting an allocation of 6-10 per cent), and while this share has increased over the last few years, many expect it to double or triple in the years ahead.
In the US, private sector pension funds look to allocate on average up to 10 per cent of assets to hedge funds, a little ahead of America’s public sector pensions, which target about 8 per cent. In the UK, some of the biggest schemes allocate up to 15 per cent of their portfolio to hedge funds. In continental Europe, the take-up of hedge funds by pensions has been more mixed, but pension funds in some markets, such as the Netherlands, have embraced hedge funds and other alternative investment strategies.
The global economic crisis provided only a temporary interruption in the growth of institutional investments. Investors pulled about $300bn (£197bn, €232bn) out of hedge funds between October 2008 and June 2009, but inflows returned to healthy levels in the second half of 2009. Recent surveys by Credit Suisse and Deutsche Bank suggest the industry may attract $200bn-$300bn of new capital this year. It appears a large part of redemptions that followed the 2008 crunch were from wealthy individuals rather than institutions, and that institutions continued contributing new capital throughout most of 2009.
As part of their own growth and maturation, and in response to greater institutional investor demand, hedge fund managers and firms of all sizes have become more institutionalised in terms of their internal systems, structures and general operational infrastructure. This can be seen in the use of risk management practices and systems, compliance procedures, performance and risk reporting, governance structures and overall operational sophistication.
Institutional investors demand the highest quality operational and risk management systems from the funds they invest in, and to attract and in response to investor feedback, hedge fund managers have developed sophisticated asset management and trading infrastructures.
These demands have required significant investments by managers in systems, technology and people. However, the benefits to investors and managers outweigh costs. The emphasis by investors and policymakers on transparency and systemic risk analysis will serve to reinforce and continue this infrastructure build.
The institutionalisation of the hedge fund industry has been a developing theme for the past 10 plus years and is likely to continue. It will also assist them to meet new regulatory demands.
Todd Groome is chairman of the Alternative Investment Management Association
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From Financial Times published on July 25 2010 09:16
