(November 13, 2012) — Institutional investors are increasingly allocating to assets they do not understand – and the fault, according to at least some in fund management, could be their own.

A report from the Center for Applied Research (CAR), an affiliate of asset manager and custodian State Street, said investors were signing up for a wider selection of alternative assets in an effort to diversify portfolios and hunt for yield.

“On its face, the convergence of institutional investors into these asset classes seems healthy,” the report said. “As we dug deeper, however, we uncovered a troubling finding: Based on our investor interviews and survey work, we found that institutional investors aren’t fully prepared to handle the complexity that comes with alternative assets.”

However, the problems were being driven by the investors themselves, the report seemed to suggest.

“Faced with growing uncertainty, many investors – both retail and institutional – are not acting in their own best interest,” the report said, “exhibiting behaviour that appears to be at odds with their stated goals.”

During the financial crisis, fund managers and other financial institutions were criticised for selling products to clients that they did not understand. The CAR report suggests this has continued rather than abated as many thought would – and should – be the case. The report entitled “The Influential Investor”, is light on detail about the sales and marketing tactics – or any change therein – by fund managers since the start of the crisis. 

Investors, the report said, are being attracted to these diversifying assets due to concerns about the macro-economic environment, which has made it increasingly difficult to secure the returns needed to reach their liabilities.

The report continued: “By increasing allocations to alternatives, despite concerns that they aren’t prepared for the ensuing complexity, it seems that many institutional investors aren’t acting in their own best interest either.”

The CAR report showed investors considered this complexity as their major challenge in the immediate future, followed by demands from regulators and ratings agencies.  However the same survey reported more than three quarters of this group as considering themselves as highly sophisticated in financial matters.

The report also criticised investment consultants and advisers for failing to adequately explain alternative assets and what they involved, to investors. It also cited a “bad faith” between investors and their providers, which was not helping them make the correct investment decisions.

“Only one-third of retail and institutional investors believed their primary investment provider is acting in their best interest. Investors reported that they do not receive sufficient financial education from their advisors,” the report said.

Fund managers were criticised by the report in one instance, however. CAR said the current method of performance measurement that used relative indices was not aligned to investors’ needs and that in future the industry would have to create a process of personal performance.

To read the full report, click here.