Although there has been a moderate decline in overall allocations to hedge funds, the majority of institutions intend to increase or maintain current hedge fund allocations over the nex
Although there has been a moderate decline in overall allocations to hedge funds, the majority of institutions intend to increase or maintain current hedge fund allocations over the next 12 months, according to a study by State Street Corporation.
The study indicates that turbulent financial markets have not caused major shifts in institutional asset allocations. Three quarters of institutional investors said they do not plan to modify portfolio allocations.
The results of State Street’s 2009 hedge fund study show a moderate decline in overall allocations to hedge funds, with institutions allocating more than five per cent of their portfolio to hedge funds decreasing from two-thirds (68 per cent) in 2007 to one half (51 per cent) in 2008.
Nevertheless, most institutions intend to either increase (49 per cent) or maintain (39 per cent) their allocation to hedge funds in the next year. The majority of funding for new hedge fund positions is expected to come from equity allocations (80 per cent), as compared to 2007 when two in five institutions (39 per cent) planned to draw from bond allocations to fund new hedge fund positions.
‘Hedge funds have not been immune to the extremely volatile market environment,’ says Gary Enos, executive vice president and head of relationship management and client strategy for State Street’s alternative investment solutions team. ‘While alternative investments, including hedge funds, largely outperformed traditional investments in 2008, negative returns understandably disappointed. Although hedge fund allocations declined slightly over the past year, we anticipate growth will resume later in 2009, as institutional investors continue to focus on diversification and risk management.’
Another encouraging sign for alternatives is increased institutional interest in private equity funds. Over half of institutions (53 per cent) have allocated more than five per cent of their portfolio to private equity funds, and half intend to increase their allocation to private equity over the next 12 months.
Among the challenges arising from the recent market volatility has been the growing difficulty in accurately valuing derivatives and other complex financial instruments. As a result, more institutions reported that accurately valuing hedge fund holdings can be problematic (77 per cent versus 55 per cent in 2007). Two-thirds of institutional investors (64 per cent) attribute the accurate valuation of their hedge fund holdings to the use of an independent fund administrator.
Institutional investors also continue to emphasise transparency. Five out of six institutions (84 per cent) expect more disclosure of hedge fund positions and nearly half (49 per cent) anticipate more frequent reporting from hedge fund managers. Meanwhile, only a few (19 per cent) currently receive some level of consistent transparency across hedge fund holdings.
The survey also suggests that institutional risk management programmes are growing more sophisticated. While one-third of institutions place a greater emphasis on qualitative analysis when monitoring the ongoing performance of alternative investments, half place an emphasis on both qualitative and quantitative analysis. Further, nearly two-thirds (61 per cent) of institutional investors either intend to (17 per cent) or already are (44 per cent) aggregating alternative investment risk exposures with other portfolio exposures to gain a meaningful assessment of risk across their portfolio.
‘The recent unprecedented market volatility has prompted institutions to increase their focus on risk management,’ says Enos. ‘To address these concerns and the increasingly difficult challenges inherent in the financial markets, the hedge fund community and allied third-party providers and administrators are stepping up efforts to develop and expand risk management solutions for institutional investors.’
Institutions say the risk of investment loss presents the greatest threat to hedge fund investing today (26 per cent). This risk resulted primarily because, while hedge fund indices outperformed equity benchmarks (such as the S&P 500 Index) by more than 20 per cent in 2008, declines in hedge fund returns still disappointed. This year, 19 per cent of investors expressed concerns about the correlation of hedge fund returns with those of traditional investments, as compared to 23 per cent a year ago.
