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» Articles - Crisis has reinforced ongoing trend toward alternative investing
Survey: Crisis has reinforced ongoing trend toward alternative investing
The hedge fund industry’s insatiable thirst for market research will be temporarily quenched by an interesting new report from SEI and Greenwich Associates. The document, called “The Era of the Investor” contains results from the firms’ second annual survey of institutional investors (conducted in November 2009).
Since this thing is destined to be well covered by the mainstream media, we thought we’d try to look a little deeper into the results and focus on some findings that aren’t immediately obvious or covered in the executive summary.
But first, the headlines…
* The good news continues to roll for hedge funds, as 95% of the 96 institutional investors surveyed this year said they would either increase or maintain their hedge fund allocations over the next year.
* “Diversification” remains the #1 reason to invest in hedge funds – followed closely by “absolute returns.”
* During 2009, transparency rose in importance with over 70% of respondents said they now request “more detailed information from managers than they did a year ago.”
* Since last year, “poor performance” has been overtaken by transparency and liquidity as the main sources of “concerns” about investing in hedge funds.
* The report says that “fee pressures have intensified” as 20% of respondents reported having “negotiated fee arrangements different that the standard ‘2/20′ for single-manager funds and ‘1/10′ for funds of hedge funds.”
Now here are some of our observations…
Why hedge funds?
While “diversification” remains the #1 reason to invest in hedge funds, fewer respondents cited it this year (31%) than last year (62%). This year, “absolute returns” ranked only a couple of percentage points behind. According to last year’s edition of the survey (conducted in August 2008 – available here – covered by AAA here), absolute returns were a distant second – more than 20 percentage points behind.
November 2009 survey…
August ‘08 survey…
Still, while “diversification tanked from 62% to 31%, more than 10 percentage points more respondents rated “non-correlated investment strategies” (a euphemism for diversification) as a primary objective.
Perhaps in response to their experience, respondents also seem to be less concerned about volatility. Last year, 20% said “decreased volatility” was an objective. This year,that number dropped to below 10%.
Transparency
A call for greater “transparency” makes for great headlines. But as SEI and Greenwich point out, “participants described their transparency expectations in various ways.” It seems that some investors wanted traditional position-level transparency while others wanted to have a better understanding of the strategy itself. (This makes a lot of sense. If your hedge fund manager traded only S&P 500 futures, but did so using some kind of market timing algorithm, then knowing whether or not you had an S&P position at a given point in time would likely not be particularly insightful.)
Nearly 85% said they were now seeking more information on “valuation methodology.” Since a majority of hedge funds trade in publicly-listed securities, this could just mean that investors wanted to confirm, say, how the manager valued securities that were untraded on the last day of the month. It does not necessarily suggest that investors have begun vetting some kind of complex valuation procedure for exotic derivatives.
Returns
As the report contends, “poor past (2-3) year performance” has all but dropped off the manager-selection checklist of institutional investors. In August 2008, 40% said it was “very important.” By November 2009 – perhaps in recognition that a lot of their favorite funds totally sucked eggs in the preceding 12 months – only 20% said immediate part performance was very important (see chart below from this year’s report).
Despite calls for greater transparency, it appears that “quality of reporting and communications” is also less important now than it was in August 2008. Back then approximately 40% ranked it as “very important” in the selection process. Today, that number is down to 25%.
What keeps investors up at night?
There were also some dramatic changes in some of the respondents’ “biggest worries” about hedge fund investing. “Failing to achieve primary objective” was cited by over half of institutions as a “biggest worry” this year. However, in the heady pre-Madoff days of August 2008, “not accomplishing stated goal” only kept 20% of respondents up at night. Even in November 2008, after the market fell off a cliff, only 40% of respondents said this was a “biggest worry.” (See chart below from report.)
Looking forward
While corporate, public and government pensions had not yet reached their “target” hedge fund allocations, foundations and endowments’ “actual” allocations to hedge funds was already higher than they have targeted. This suggests that foundations and endowments may actually pare back a little over the coming years.
The authors are a little cynical when they write that some hedge funds have accommodated managed accounts “perhaps with an eye to resetting high watermarks.” In our opinion, investors more likely used the negative incentive of walking away, rather than the positive incentive of forgiving past performance sins.
For more information, or to discuss your specific situation, please contact me directly.
Lisa Rivera
Director of Industry Relations and Outreach
Chartered Alternative Investment Analyst Association
Now that you have read this, what do you think? Do you have other ideas? Please share you views with other members (eg by blog or discussion form) and/or request professional member(s) to contact you directly.
