Institutional investors dominate the hedge fund market – corporate and union pension plans, charitable foundations, and university endowments – in assets, reach, and in managers who seek to market to them. What do they want from their investments?
As of June 30, 2014, according to the Managed Funds Association, 65% of the nearly $3 trillion in assets in hedge funds were institutional dollars.
Below are some key findings from the Preqin Special Report “The Real Value of Hedge Fund Investment.”
1. Most Institutional Investors Have Realistic Return Goals
Nearly two-thirds of institutional investors have relatively modest goals – they are looking for an average annual total return between 4% and 6%
2. A Majority of Institutional Investors Want Risk Mitigation
A primary concern was to mitigate risk: “80% believed that their portfolio risk would increase if hedge funds were removed from their portfolios, ” said the MFA. In other words, they used hedge funds to hedge their risk.
3. Institutional Investors Prefer to Measure Performance vs. Narrow Benchmarks
The majority (89%) of institutional investors preferred to measure a hedge fund performance against a specific and narrow benchmark, not versus broader benchmarks like the Standard & Poor’s 500 Index, the NASDAQ, the Dow Jones Industrial Average, or the Barclay Bond Index. Why? The answer is in uncorrelated returns. This means that, if the stock market loses value, the hedge fund investment will rise. In other words, they use hedge funds to increase their diversification.
4. Institutional Investors Think That Hedge Funds Have Met Expectations
84% of institutional investors believed that their hedge fund allocations met or exceeded their expectations during the twelve months ended June 30, 2014.
5. Institutional Investors Plan to Allocate More to Hedge Funds
And here’s the better news: 87% of institutional investors planned to increase their hedge fund allocations during the next 12 months.
These large investors have allocated less than 20% of their assets into hedge funds. The typically more conservative investors, such as pension funds, insurance firms, and sovereign wealth funds, allocated less than 10% of their total investable assets to alternative investments.
Is there room for the small, mid-sized, and start-up alternative investment manager to market their funds to non-institutional investors? The answer, according to a February 2015 McKinsey & Company report, appears to be yes.
Smaller investors, those with less than $2 billion in AUM, invested by small teams of generalists) say they seek the enhanced performance and diversification that alternatives can potentially deliver, for example, unconstrained bond strategies as a replacement for core fixed-income holdings.”
Another hopeful sign for the smaller alternative investment manager is the potential “boutique bias’ by investors for specialist managers with unique stories.
Infographic courtesy of the Managed Futures Association.