Basic HTML Version
10
I
Institutional Investment in Hedge Funds: Evolving Investor Portfolio Construction Drives Product Convergence
Institutional Inflows Change the Character of the
Hedge Fund Industry
From 2003-2007, institutional inflows worked to significantly
change the character of the hedge fund industry. Up until
the early 2000s, the majority of investors in the hedge fund
industry had been high net worth individuals and family
offices looking to invest their private wealth.
As shown in Chart 3, in 2002 these high net worth and
family office investors were seen as the source for 75% of
the industry’s assets under management. Even though these
investors continued to channel assets to the hedge fund
industry in the subsequent 5 years, their flows were unable
to keep pace with the wall of institutional money entering
the market.
By 2007, the share of capital contributed by high net worth
and family office investors had fallen nearly 20 percentage
points. It was for this reason that many began to talk about
the industry as becoming “institutionalized”. As will be
discussed, the drop in high net worth and family office interest
can be directly related to this institutionalization.
At the outset of this period in 2003, institutional investors
only accounted for $211 billion AUM, or 25% of the industry’s
total assets. Inflows from 2004 to 2007 caused this total
to rise sharply, reaching $917 billion, or 43% of total
industry assets.
Institutional investors entering the market were looking for
risk-adjusted returns and an ability to reduce the volatility
of their portfolios. This was a very different mandate from
the one sought by high net worth and family office investors—
namely, achieving outperformance and high returns on what
they considered to be their risk capital. This difference in
their underlying goals helps to explain continued shifts in the
industry’s capital sources in the period subsequent to 2007.
While down sharply during the global financial crisis, hedge
funds were still able to post better performance than long-
only managers held in investors’ portfolios, and they helped
to reduce the portfolio’s overall volatility. Institutional
investors focused on this outcome and saw hedge funds as
having performed as desired. High net worth and family office
investors saw this outcome as disappointing.
Since that time, many high net worth and family office
investors have exited the hedge fund industry to seek better
returns in other investment areas such as art or real estate, but
institutional investors for the most part maintained and even
extended their hedge fund allocations. The result has created
a denominator effect. As of the end of 2011, we estimate
that institutional investors as a group accounted for 60%
of the industry’s assets. While this appears to have jumped
sharply since 2007, much of the increase is because overall
high net worth and family office allocations have gone down.
Between 2007 and 2011, we estimate that high net worth and
family offices’ share of hedge fund industry AUM fell from
57% down to only 40% of total assets.
“ We are currently in a period of structural change. There
was a secular shift from long only to hedge funds in the past
few years,”
– <$1 Billion AUM Hedge Fund
“ We’re starting to get allocations from what used to be the
investor’s traditional asset class buckets. To some extent,
it depends on who’s advising them. We’re getting more
and more of that active manager bucket and the bucket’s
getting bigger,”
– >$10 Billion AUM Hedge Fund
0
200M
500M
600M
800M
1,000M
1,200M
1,400M
1,600M
1,800M
2003 2004 2005 2006 2007 2008 2009 2010 2011
60%
25%
43%
Institutional Investors including
Endowments & Foundations,
Pension Funds, Insurance
Funds & SWFs
High Net Worth Individuals
& Family Offices
Millions of Dollars
Chart 11
Chart 3: Sources of Hedge Fund Industry AUM
By Investor Type
“ All of our capital last year came fromUS institutional investors.”
– $5-$10 Billion AUM Hedge Fund
“ Private investors just look back 3 years and see how they’ve
performed and from that perspective, hedge funds have
just not been sexy enough. They haven’t been able to show
consistent performance across 2009, 2010, and 2011 to
convince the private audience that they do what they say
they do,”
– Asset Manager with Hedge Fund Offerings
Source: Citi Prime Finance analysis based on eVestment HFN data