Institutions to invest USD85bn in hedge funds by 2008, says report

Whereas the majority of commitments to hedge funds a decade ago came from high net worth individuals and families, foundations and endowments, today the hedge fund industry is receiving greater levels of backing from institutional investors of this type than at any previous point in the history of the asset class, the report says.

Last year, according to Preqin Hedge, managers raised a total of USD160bn from institutional and high net worth investors combined, but the report says that to maintain these levels, the industry must adapt to the demands and requirements of institutional investors.

Public pension plans form 23.8 per cent of all institutional investors in hedge funds, the report says, and are the industry’s fastest-growing source of institutional investment. Endowments make up 16.7 per cent of all institutional investment into hedge funds, while family offices and foundations form 12.4 per cent.

The majority of hedge fund investors are US-based, with the California Public Employees’ Retirement System (CalPERS), the biggest US pension scheme, the largest single investor in hedge funds with USD11.5bn. Preqin Hedge says that with a target allocation of 8 per cent, CalPERS’ investment in hedge funds is set to rise to USD18.4bn over the next three years.

The US pension scheme with the largest proportion of its assets invested in hedge funds is the San Diego County Employees Retirement Association with 20 per cent of the total. Across the country’s northern border, the Ontario Teachers’ Pension Plan has a 12 per cent allocation to hedge funds amounting to some USD10bn invested with more than 150 managers. Among endowments, the University of Texas Investment Management Company has 28 per cent of its total assets, some USD6.3bn, invested in absolute return funds.

US public pension schemes allocate an average of about 6 per cent of their total assets to hedge funds, but family offices and foundations frequently dedicate a higher proportion, the report says, with a typical allocation of between 15 and 25 per cent and in some cases 40 per cent or more. The Atlantic Philanthropies Endowment has a target allocation to hedge funds of 50 per cent of total assets.

Preqin Hedge says that endowments, family offices and foundations are mostly close to filling their target allocations to hedge funds and are unlikely to increase them over the next 12 to 24 months.

However, the report says public pension plans are likely to increase their average allocation to between 8 and 9 per cent over the next two years. With a large proportion of these pension funds already short of their existing target allocations, this represents a significant proportion of the USD85bn that is forecast to be invested in the hedge fund market by institutional investors by 2008.

However, Preqin Hedge says Europe and Asia are becoming increasingly important source of institutional capital for hedge fund managers, with investors from these regions now entering the arena at a greater rate than from North America. Five of the top 25 institutional hedge fund investors identified by the report are European, headed by ABP Investments of the Netherlands.

The report also notes that exposure through fund of hedge funds is the most common strategy used by institutional investors, with 65 per cent of active public pension plans committing to fund of hedge funds as part of their strategy.

In some cases funds of funds are part of a wider portfolio that includes some direct investments, while about 20 per cent of public pension plans eschew funds of hedge funds for direct investment in single-manager funds because they are put off by the double layer of fees.

By contrast, family offices, foundations and endowments, which typically have considerably longer experience of hedge fund investment, are the most prolific investors into single-manager funds, with up to 80 per cent of all active members of these categories having a direct investment strategy or one combined with funds of funds.