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Institutional Investment in Hedge Funds: Evolving Investor Portfolio Construction Drives Product Convergence
Other organizations, particularly many public pensions, came
up with a different portfolio configuration to enable their
hedge fund investing. The boards and investment committees
at these organizations wanted to have more oversight and set
tighter parameters around how capital was invested. These
organizations tended to have a very structured investment
process that required extensive oversight and approvals.
Moreover, these investors often worked with consultants
that required specific mandates around the type of assets
permitted in the portfolio and the size of assets they would
be advising.
These investors and their advisors developed the concept of
porting their alternative alpha streams away from the main
equity or bond allocation to a new sleeve within their portfolio
that became broadly known as the alternatives bucket. This
portfolio configuration is illustrated in Chart 5.
Each type of investment permitted within the alternatives
bucket had a specific allocation and its own set of policy
guidelines. In this way, the new investments were set up
like an additional asset class in line with the approach used
in the traditional equity and bond portions of the portfolio.
This accommodation was made because there was not an
appetite to have the flexibility of an opportunistic bucket.
Most investors using this portfolio configuration acknowledge
that they do not truly see hedge funds as an asset class,
but they nonetheless count them in this way to satisfy their
allocation rules.
Because many pensions have adopted this approach and they
are by far the largest category of institutional investor, this
has since become the dominant portfolio configuration for
investors in the hedge fund industry. What is important to
note about this configuration and the opportunistic approach
is that in both instances the capital allocated to hedge funds is
coming from a satellite part of the portfolio that typically only
accounts for a small percentage of the institution’s overall
pool of assets. The core of the portfolio remains in the equity
and bond allocations.
As will be explored in the next section, there are signs
emerging that institutional investors may be in the midst of
another foundational shift in how they look to configure their
portfolios, the result of which may work to reposition hedge
funds from a satellite into the investor’s core allocations.
“ Family offices can invest in what they want. Sovereign
wealth funds also can do what they want. They set up an
opportunistic bucket just so that they’ll have a place to
invest in what they want,”
– >$10 Billion AUM Hedge Fund
“ We have a 0%-8% allocation to an opportunity fund. We can
put anything short term in nature here or something that
doesn’t fit in the portfolio like hedge funds or commodities.
There is no pressure to put anything in, though,”
– US Public Pension
Passive
Active
Passive
Active
Chart 13
Hedge Funds
Private Equity
Infrastructure & Real Assets
Equity
Bonds/
Fixed
Income
Alternatives
Chart 5: Institutional Portfolio Configuration:
Dedicated Alternatives
“ Interest has come from the public plans and has been
driven by adoption of policy change to allow them to invest
in alternative strategies,”
– $1-$5 Billion AUM Hedge Fund
“ Big institutions out there had governors on their long-only
buckets that limited their ability to allocate to alternatives.
That’s why they came up with portable alpha.”
– <$1 Billion AUM Hedge Fund
“ For allocation purposes, we treat hedge funds like a separate
asset class even though we realize that they’re not,”
– European Public Pension
“ Liquidity issues and impacts of hedge funds that differ from
traditional investments drive the thought of putting hedge
funds into alternative buckets,”
– US Corporate Pension Plan
“ Most of our clients view hedge funds as a strategy, but bucket
it as an asset allocation. Our clients understand that you can’t
determine whether hedge funds are over- or undervalued.
It’s a strategy, but they track it as an asset class,”
- Institutional Fund of Fund
Source: Citi Prime Finance