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Institutional Investment in Hedge Funds: Evolving Investor Portfolio Construction Drives Product Convergence
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allocated to hedge funds back to the 2006 levels for both
pension funds and sovereign wealth funds. Instead of following
this same methodology for E and Fs, where we have already
seen a decline in the share of alternatives being targeted at
hedge funds, we instead opted to hold that allocation at the
2011 level.
As shown, if this scenario holds true our forecast is that total
institutional assets will flatten out near the industry’s current
levels, rising only minimally from $1.47 trillion to $1.51 trillion
by 2016. This forecast is detailed in Chart 19. As shown, overall
allocations remain broadly unchanged from each segment in
this forecast.
While this scenario is certainly possible, the majority of survey
participants did not share some participants’ pessimism
about how returns of the past 15 months are likely to affect
the industry overall, and instead expressed a much more
optimistic view.
Most Participants See Institutional Interest
Continuing to Rise
While a number of interviewees did express concern about
institutions’ continued interest in hedge funds, most
participants instead pointed out factors that were likely to
drive institutional interest even higher for some time to come.
Many of the organizations we interviewed had either recently
increased or were newly entering the alternatives and hedge
fund space.
Foremost among the factors driving a view that institutional
interest will continue to growwas the nature of their portfolios.
These investors are looking to address long-term obligations
or structural cash imbalances. Based on actuarial estimates
and funding needs, many of this institutions’ return goals
are 8%-10%. and they wish to achieve these returns without
excessive downside risk.
This is not the type of “fast money” that pursues octane-
fueled returns, nor is it the type of money that is likely to
cause investors to rethink their allocation approach based
on 1 or 2 years of market performance. As we explored in
depth in last year’s survey, these participants take long-term
views of their portfolio and are known across the hedge fund
community for offering “sticky money”.
For pension funds in particular, rising liability gaps and an
aging population are driving participants to remain aggressive
in seeking diversification and pursuing strategies that will
limit their downside exposure.
According to Towers Watson, the US represents 58.5%
of global pension assets. The asset-to-liability gap in US
state pensions has been estimated at more than $1 trillion
according to the latest Pew Center for The States survey,
and some academic studies suggest that the figure could
actually be as much as $3-$4 trillion. US corporate pension
funds recorded their largest deficits ever in 2011, with the gap
between assets and liabilities for the 100 biggest portfolios
hitting a record $327 billion according to industry specialist
consulting firm Milliman, publishers of the Milliman 100
Pension Funding Index.
$200
$400
$600
$800
$1,600
0
$1,200
$1,400
$1,000
2006
2011
2016 Estimate
Chart 27
$683
74%
$977
66%
$958
8
63%
$364
25%
$400
26%
$89
10%
$133
9%
$153
10%
$917B
$1,474B
$1,511B
$145
16%
+ $37B
Pension Funds
SWFs
E&Fs
Billions of Dollars
Chart 19: Projected Institutional Hedge Fund
Assets: 2016 Based on Declining Alternative &
Hedge Fund Interest
Source: Citi Prime Finance Analysis based on Towers Watson, SWF Institutte, OECD,
NACUBO Commonfund & eVestment HFN data
“ Most institutions in Europe are not there yet in terms of
hedge funds. We and the Dutch have been moving ahead,
but other organizations are still gearing up,”
- European Public Pension
“ I see hedge funds remaining in some way shape or form in
our book for the long run. We’ve been in the space much
longer than many other pensions and we see our interest
continuing. We’re now also seeing more and more other
pensions getting into the space,”
- US Public Pension