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Institutional Investment in Hedge Funds: Evolving Investor Portfolio Construction Drives Product Convergence
E and Fs Trim Hedge Fund Allocations
Asset allocation trends from the largest E and Fs are adding
to the overall level of concern. The National Association
of College and University Business Officers (NACUBO)
Commonfund Endowment Study that surveys more than 800
US and Canadian endowments found that overall hedge fund
allocations from this segment have declined since their peak
in 2009. These declines were most evident from the largest
endowments with more than $1 billion in assets.
As shown in Chart 16, E and Fs with more than $1 billion in
assets had steadily increased their hedge fund allocations
between 2002 and 2009, growing from 17.8% to 24.4% of
their total assets. This trend reversed in 2010 and continued
lower in 2011 as this group’s total allocation declined to only
20.4% of assets.
Because of the skew these large organizations represent in
terms of total E and Fs capital, their shift in course is causing
the segment’s entire dollar-weighted allocation to hedge
funds to dip as well.
For many years, E and Fs with more than $1 billion in assets
had the highest share of money allocated to hedge funds, and
those organizations at lower asset bands had less of their
wallet focused on hedge funds. In recent years, however, that
pattern has reversed and by 2011, the E and Fs structure had
inverted. The largest organizations had the lowest allocation
to hedge funds, and the smaller E and Fs had the highest
allocation.
These large endowments were the market leaders on which
other institutional investors modeled their approach of
including hedge funds and alternate alpha streams in their
portfolio. Seeing a reversal of the more than decade-long
trend toward increasing assets from this segment has many
investors worried that this may be seen as a signal by other
institutional investors. As noted in the following quotes, there
were indeed some signs of institutional investors reversing or
pausing in their hedge fund investment programs.
“ S&P is the internal yardstick. When individual hedge fund
managers are down more than the market, a lot of allocators
didn’t even think that was possible as a concept in equity
long/short. There’s more runway for macro and other
strategies where there is not as obvious a yardstick,”
– Long-Only and Alternatives-Focused Consultant
“ If hedge funds offer 80% of the performance with 40% of
the volatility, that may not be enough. With our client base,
the associated operational headaches, the lock-ups, the lack
of transparency requires equity-like returns to warrant all
the headache. 100% of the returns at 50% of the volatility
might be OK, but 80% and 40% won’t cut it,”
– Long-Only and Alternatives-Focused Consultant
“ We are at a real tipping point. A lot of clients still really
believe in risk-adjusted returns, but returns for the past 2
years have pretty much been aligned to long only. This is
going to call into question the huge asset flow from long
only into hedge funds. The risk is that this trend could
reverse or at a minimum pause,”
– Long-Only and Alternatives-Focused Consultant
“ Clients are wondering why hedge funds are not performing
and they can’t compete in an up market rally”
– Fund of Fund
Chart 23
HFRI Equal Weighted Index
S&P 500 Index
Jan-11
Feb-11
Mar-11
Apr-11
May-11
Jun-11
Jul-11
Aug-11
Sep-11
Oct-11
Nov-11
Dec-11
Jan-12
Feb-12
Mar-12
-8%
-6%
-4%
-2%
0%
2%
4%
6%
8%
10%
12%
Chart 15: Comparison of Hedge Fund & S&P 500
Monthly Returns: January 2011-March 2012