Investors reward hedge funds with increased allocations

A Russell Investments survey has found that allocation to alternative investments, including hedge funds, is set to rise, despite an increased awareness of the risks involved.

The 2010 Global Survey on Alternative Investing found that the majority of investors were “staying the course”, with the overall market allocation to alternative strategies forecast to rise from 14% in 2009 to 19% by 2012.

Survey respondents listed reducing volatility (83%), improving returns (76%) and improved risk-adjusted performance (61%) as the most important motivating factors in encouraging increased levels of alternative allocations. 

According to the findings, hedge funds are expected to benefit from the increased allocation to alternative investments. It is predicted that the hedge fund share of institutional investment portfolios will rise by 1.5%, reaching 5.7% by 2012.

The perception of hedge funds in Europe post-credit crunch was found to be more negative than in North America and Asia. One respondent commented: “Our trustees want to see the waters clear a little before getting back into hedge funds.” Therefore recovery was predicted to be more robust in those markets than in Europe.

The findings indicated that there remained a division among institutions who preferred direct investment in hedge funds and those that opted to use fund of hedge funds (FoHFs). The benefit of FoHFs was perceived as allowing investors to outsource appropriate expertise across multiple asset classes and strategies.

However, the negatives weighted against this were additional costs, reduced transparency and limited access to individual managers. It was recorded that some respondents that had previously used FoHFs were researching alternative ways to select skilled fund managers.

The two factors identified by respondents as major deterrents from increasing levels of alternative allocation, illiquidity (46%) and high fees (34%), were issues found to be particularly associated with hedge funds.

Long/short and global macro strategies were seen as offerings that negate this to some extent because of increased levels of diversification.

The survey also highlighted the growing awareness of the value of risk management when investing in funds.  Many institutions were undertaking to improve mechanisms of in-house assessment of the risks inherent in alternative investments.

Another development in the hedge fund universe uncovered by Russell Investments’ report is the move towards negotiable fees. It is predicted that as institutes’ asset holdings in funds continue to rise, the investors will become increasingly able to use this influence to discuss flexible fees.

This budding investor prowess is also predicted to oblige hedge fund managers to provide a more transparent and accommodating service to meet institutional demands, the report concluded.