European institutional investors don't know how to benefit from hedge fund investments, according to a major new EDHEC survey.

The results of the EDHEC European Alternative Diversification Practices Survey, which received responses from 151 major European institutional investors and enabled EDHEC to produce a detailed assessment of current institutional practices in Europe, were published on 9 January.

The questionnaires for the survey were addressed to the top 1,000 institutional investors in Europe in the first half of 2005 and the study generated responses from institutional investors representing, at 30 September 2005, a total volume of over EUR 1 trillion of assets under management. The survey shows that 51per cent of European institutional investors are already exposed to hedge fund strategies. These represent, on average, 7per cent of their global assets.

The main conclusion of the survey is that institutional investors do not know how to take advantage of the diversification possibilities of hedge funds because they have both insufficient knowledge of the risks to which their assets are exposed and an ineffective asset allocation policy.

More specifically, among the findings of the survey are the following:

• Only 29 per cent of European institutional investors appear to be capable of carrying out a risk analysis independently of that provided by the fund manager and only 48 per cent of them appear to be capable of integrating these risks in a global analysis of the risks of their assets.

• 73 per cent of European institutional investors manage an optimal mix of asset classes without distinguishing between passive and active products.

• Only 33 per cent of European institutional investors have implemented a core/satellite approach to constructing their portfolio.

• While 67 per cent of European institutional investors claim to take the risk factors to which their hedge fund investments are exposed into account in their allocation, only 30 per cent distinguish hedge funds between strategies or by grouping them into types of risks, which prevents them from taking advantage of the diversity of hedge fund strategies.

• 45per cent of European institutional investors do not have any allocation policy, and among the 50per cent following either a pure quantitative approach or a mix of quantitative and qualitative analysis, a majority opt for the mean/variance framework, which is clearly ill-suited to the construction of portfolios of hedge funds.

• However, a switch from the focus on alpha (absolute return) to a focus on beta (normal returns due to the risks taken) appears to be well under way. As such, 67 per cent of European institutional investors already consider that hedge funds are diversification complements, which are meant to improve the diversification of their portfolio; 8 per cent of them even consider that hedge funds are an essential element of a well diversified core portfolio.

• In terms of investment vehicles, 74 per cent of European institutional investors invest in hedge funds through diversified funds of hedge funds, but only 37per cent invest directly in single hedge funds. A mere 2 per cent of European institutional investors invest in single strategy indices.

The survey is one of many reports and studies that will be discussed with institutional investors and hedge fund industry professionals at the EDHEC Hedge Fund Days at The Brewery in London on February 15th and 16th 2006.

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