By Simon Kerr
This trend in the use of alternatives reflect the new frameworks with which institutional investors and their consultants are building portfolios, with exposure defined less by product packaging or home bias, and more by the specific contributions investments make toward overall objectives. The framework is part of the new emerging paradigm for asset allocation amongst investing institutions in North America, shown in the Graphic of the Day below, and which will reinforce hedge fund growth.
Graphic of the Day – Hedge Funds Break out of The Box
The Emerging Institutional Investment Framework
Source: Casey Quirk (Note Not to Scale)
The key point in this is that the way institutional investors see how they can use hedge funds is changing. It was hedge funds as part of an alternatives category – in a segmented ghetto by risk/return. This is changing towards hedge funds as sources of alpha within broader asset categories. Hedge funds are breaking out of the box!
- Managers offering non-correlated investments.
- Firms offering both “traditional” and “alternative” investments will stand the best chance of providing institutional clients with a total portfolio solution.
- Product development and innovation will remain critical competitive differentiators.
The survey collators go on to turn their gathered insights into a product opportunity map – showing where demand for product will be strongest.
2011 Product Opportunity Map
Source: Casey Quirk, eVestment Alliance
- First, most North American institutional investors selected a core fund of hedge funds in recent years, and few are yet convinced they need a change.
- Second, and more importantly, larger investors now seek more specialized FOHF strategies in place of, or in addition to, a diversified FOHF mandate. This challenges many FOHF vendors who do not offer a focused product.
- Finally, larger institutional investors—particularly well-funded non-profit funds—still seek to avoid higher fees and pooled vehicles offered by FOHFs.
The trends identified by the survey authors will likely persist for some years, as allocations in pension plans change slowly, and allocations to hedge funds are going up – doubling in some forecasts. So hedge fund capital flows should be positive at the industry level on a multi-year outlook. There is still a role for funds of hedge funds serving American institutions, and indeed there should be growth in assets this year and next for funds of hedge funds as a whole. But to benefit from those allocations funds of hedge fund businesses are going to have to be in the top quintile of performance ranking over 5 years, and in 2008 specifically, or have a very good specialised product (by geography or investment strategy) to offer.
*This year, 55 investment consultants, representing an aggregate $10.4 trillion of assets under advisement participated in the survey.