Greenwich Associates reports that US institutional investors are making growing allocations to alternative investments, including hedge funds.
In its recent report entitled 'Asset Allocation: US portfolios adjust to difficult markets in 2002' Greenwich Associates reported that from 2000 to 2002, US pension funds and endowments/foundations registered significant changes in their asset allocations.
Through changes in portfolio strategies, active rebalancing, asset diminishment, or a combination of these factors, these funds greatly reduced their investment in domestic equity while proportionally increasing their fixed income holdings.
Although still a small part of overall assets, the move into alternative investments - private equity, hedge funds and equity real estate - has been dramatic.
Use of alternatives by institutional investors grows significantly
Use of alternative investments continues to grow at corporate and public pension funds, and most significantly, at endowments and foundations. Although the use of private equity levelled off this year, nearly 40 per cent of all funds use this asset class. The portion of endowments and foundations using private equity exceeds 60 per cent.
Twenty per cent of all plans are now using hedge funds, up from 15 per cent last year. Nearly 60 per cent of endowments and foundations invest in hedge funds, up from 50 per cent last year.
Significant shifts are expected to continue into hedge funds and other alternative investments as they offer funds opportunities to diversify their portfolios and capture absolute, as opposed to relative, returns. In the current business environment, the past returns of these investment types may cause plan sponsors to overlook the risks of the asset class as well as the high fees and the fact that they are buying at the top of the market cycle.
Although growing in popularity, alternative investments make up only a small part of total asset allocation. Allocations to private equity investments remained stable at 3.1 per cent at endowments and foundations. Among those investing in hedge funds, allocations to hedge funds are higher at 7 per cent, driven by endowments who are the prominent investors. Allocations to hedge funds by endowments investing in hedge funds are nearly 15 per cent.
Alternative assets are viewed as less of an 'alternative' for corporate funds than others. Taken together, equity real estate, privaet equity, and hedge funds represent no more of the corporate asset mix in 2003 in proportional terms than they did in 2001.
Private equity investment dropped from 2.3 per cent to 1.9 per cent and modest gains in the other two categories did little more than make up for the difference.
Public pension funds
Public pension funds saw their assets decline as well. A matched sample of 199 large public pension funds saw their assets drop by an average of 9.3 per cent from 2001 to 2002, not good news but better than what their counterparts at corporate funds experienced.
Total public fund value in absolute dollar terms, among a sample of 199 large pension funds, dipped from US$1.82 trillion to US$1.65 trillion.
Alternative investment did not pick up among public funds in proportional terms, except in equity real estate, which grew slightly from 3.9 per cent to 4.2 per cent.
Endowments and Foundations
Endowments and foundations have been the biggest drivers in the rise of alternative asset classes, particularly with private equity and hedge funds, where they not only lead the charge but comprise most of the herd.
Private equity makes up 8 per cent of endowment/foundation assets, up from 7.3 per cent in 2001. The proportion of hedge fund use alone nearly doubled in the past year, from 4.8 per cent to 7.8 per cent, and in absolute dollar terms spiked up healthily as well.
Dev Clifford of Greenwich Associates said: "The endowments avoided the double-digit performance declines in value experienced by the corporate funds, and the public funds did better too, but they accomplished this in fundamentally different ways."
Dev Clifford continued: "The endowments secured a better performance via heavy alternative investments, while the publics found shelter by sticking with bonds."
Just over 20 per cent of funds expect to make significant asset allocations over the next year. Among these funds, the most common expected moves are to increase private equity, hedge funds, real estate, active international allocations; and decrease fixed income and domestic common stock exposure.
Alternatives are the big projected gainer, particularly hedge funds. Of the 203 funds currently with hedge fund stakes, one-third expect to invest more and not one fund says they will invest less. Private equity expectations are nearly as positive, while the bulls outnumber the bears in equity real estate by a better than four-to-one ratio.
Background Note: The above extracts were taken from the Greenwich Associates report entitled 'Asset Allocation: US portfolios adjust to difficult markets in 2002'. In this report, based on interviews with more than 1,000 of the largest corporate pension funds, public pension funds, endowments, and foundations in the US, Greenwich Associates examines trends in asset mix. In the introduction to the report, the firm stated:"Asset allocation - more than manager or security selection - is the main driver of returns. Therefore, especially in today's economic and financial environment, many plans are going back to basics and reviewing their asset allocation strategies seeking greater diversification and enhanced returns."