Asset Owners Scale Up Hedge Fund Pools | Chief Investment Officer

More institutions—40—grew their hedge funds portfolios above $1 billion than cut or reduced them over the last 12 months, despite major exits such as the New York City Employees’ Retirement System.

“These investors are the cornerstone of the asset class and a potential mass exit could indicate worrying times for the industry.”Large-scale asset owners grew by a net $28 billion in the year to the end of June, according to Preqin. This was despite 29 asset owners reducing or removing their hedge fund allocations in the same period.

Both public- and private-sector investors in the US have hiked allocations, including the Mars Pension Fund (to $1.1 billion, or 24% of the portfolio), the University of California (up by $1.2 billion), and the State of Wisconsin Investment Board (up by $1.2 billion), Preqin said.

“These institutions”—the so-called $1 billion club—“have significant resources, not only in terms of assets but also in regards to human capital,” Preqin’s report stated. “With such large allocations to hedge funds, the $1 billion club investors often employ dedicated individuals and teams focusing on hedge fund investment in order to build and oversee hedge fund portfolios.”

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These asset owners are more likely than those outside the club to move away from funds-of-funds, Preqin said, given their “sophistication and expertise.”

The 238 investors in the $1 billion club make up less than 5% of all those covered by Preqin’s database of hedge fund allocators, but they control almost a quarter of the capital.

“With this in mind, it is understandable why the actions of some high-profile institutions withdrawing capital from hedge funds may draw headlines,” the report concluded. “These investors are the cornerstone of the asset class and a potential mass exit could indicate worrying times for the industry.”

However, Preqin argued that recent signs were positive: “There are more members of this exclusive club than ever before and their exposure to hedge funds has grown collectively by nearly $30 billion over the past 12 months. With big ticket sizes and the continued support of the hedge fund industry, the $1 billion club is likely to remain important, influential and active in the asset class for some time.”

Read Preqin’s $1 Billion Club report in full: “The Largest Investors in Hedge Funds.”

Any private equity firm with a fluffed track record ought to steer clear of large allocators ($5 billion-plus), funds-of-funds, and all North Americans.

Or just not fudge their numbers.

Allocators reported vast differences in quantitative due diligence practices to data firm eVestment, which surveyed pensions, endowments, insurers, and private equity funds-of-funds. These limited partners (LPs) managed $3.4 trillion in total assets and $140 billion in private equity, from North America, EMEA, and Asia.

Inconsistency across managers’ return methodologies plagued LPs of every stripe—one of the few points of agreement. Eight out of ten LPs surveyed said it wasn’t “easy to compare one fund manager’s performance numbers with another” fairly and consistently.

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This longstanding lack of standardization “is still viewed as a challenge,” eVestment’s report stated, and threatens “breaking down the trust” between LPs and general partners (GPs).

How Often LPs Trust Manager-Provided Data Private Equity Performance Data eVestment Source: “Private Equity LP Due Diligence Trends 2016,” eVestment

Trust in GPs has already lapsed for more than half of fund-of-funds respondents (54%), who “rarely or never” trust manager-provided data.

In striking contrast, nearly all surveyed pensions and endowments (94%) “often” have confidence in GPs’ numbers. But that’s not to say institutions took managers at their word.

The ‘trust but verify’ maxim reflected in this group’s due diligence practices: Half of pensions and endowments always recalculate track records, the survey found, versus 38% of funds-of-funds.

Size of private equity portfolios also correlated strongly with return verification. Below $5 billion, roughly one in three LPs took this step, while 88% of investors overseeing $5 billion-plus said they “always” recalculate.

Asked for advice to GPs for fostering trust (and thus assets under management), LPs shared a common message: Transparency.

“Just tell us—‘this is what my performance is, this is why,’” said one allocator. “We’re going to find it anyway, and the fact that it takes my time and your time is just a waste of both of our times to get there in the end.”