Survey: Institutional Investors Pursue HFs, Direct Investing

(June 28, 2011) — Research by Citi Prime Finance shows institutional investors had $1.1 trillion in hedge funds at the end of the first quarter.

This compares with $125 billion in 2002, an amount that represented about a fifth of the hedge fund industry.

At the same time, following the global financial crisis, the firm found a noticeable shift to direct investing in hedge funds by pension and sovereign wealth funds, as opposed to using traditional fund-of-funds. “While the conventional wisdom is that directly allocated capital is going only to the largest hedge fund managers, we actually found that smaller hedge funds managing between $1 billion and $5 billion experienced the largest net growth in 2010,” Sandy Kaul, US Head of Business Advisory Services, told the Financial Post.

Kaul added: “Fund managers in this range occupy a ‘sweet spot’ for investment allocators, with interest extending as low as $500 million in developed markets and $250 million in emerging markets. Above $5 billion we see a bifurcation in the industry among hedge fund managers that are limiting new investment and those that are developing into larger asset management organizations.”

The report asserted: “Many pension and sovereign wealth funds began their hedge fund investing program using fund-of-funds as a way to initially access the market and learn about the space. As their education advanced, many chose to begin shifting toward a direct investing program. This was already occurring by 2006-2007, but the financial crisis and Madoff scandal accelerated this trend…”

Citi’s research — titled “Global Pensions and Sovereign Wealth Funds Investment in Hedge Funds: The Growth and Impact of Direct Investing” — found that global pension and sovereign wealth fund allocation to hedge funds currently totals about 3% of the pension and sovereign wealth fund asset pool of $31 trillion, or $820 billion.

Furthermore, the study found that most pension and sovereign wealth funds still seek outsourced chief investment officers, consultants, or fund-of-fund advisors to aid in their direct allocating. “The shift to direct hedge fund investing has been dramatic since the global financial crisis — particularly among larger pensions and sovereign wealth funds,” the report noted. “These participants have not settled on a standard model or approach as most still look to outsourced CIOs, consultants or fund-of-fund advisors to support their direct allocating efforts.”

The study was based on interviews with about 60 major investors representing $1.65 trillion in assets under management as well as hedge fund managers representing $186 billion in assets under management.

Click here to read “The End of the 3 and 30”, from the summer issue of aiCIO, which looks at how hedge funds-of-funds must adapt or perish.