Putting the ‘Hedge’ Back in Hedge Funds

(May 17, 2013) – A new model for allocation is redefining how institutional investors think of hedge funds: They’re not alpha machines, but a way to hedge one’s fund, a Citi Prime Finance survey has found.   

Whereas hedge funds typically occupy their own bucket or part of an ‘alternatives’ allocation in asset class-based portfolios, risk-focused investors bucket based on strategy.

“After lengthy discussions with our board, it was agreed that the overall purpose of hedge funds in our portfolio is to be a diversifier for the equity bucket,” one pension fund respondent told Citi. “Alpha generation is not a stated goal.”

Despite the sector’s weak overall returns of late, Citi analysts project global institutional investment in hedge funds to increase 56% by the end of 2017, reaching an all-time high of $2.3 trillion. Overall, they predict allocation to alternative investment products will triple by 2017.

One university endowment investor expressed faith in hedge funds’ ability to diversify-if the investor is capable of executing a well-crafted portfolio. “If we allocate the right way and do our homework right, it will create a portfolio that is differentiated,” the interviewee said. “When rolled up at the overall portfolio level it won’t have any more volatility than a portfolio of un-volatile managers.”

Institutional investors already account for 66% of total hedge fund assets under management; by 2017, Citi foresees the proportion rising to 71%. As money flows in from endowment, pensions, foundations, and sovereign wealth funds, family offices and high net worth individuals are expected to dial back their allocations.

The report is based on 82 interviews with asset owners (39% of participants), hedge fund managers (38%), consultants (9%), asset managers (7%), and intermediaries (7%).