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I
Institutional Investment in Hedge Funds: Evolving Investor Portfolio Construction Drives Product Convergence
Similar pension funding gaps exist in Europe and Asia. Towers
Watson notes that Japan is the world’s second largest source
of pension assets, with 12% of total global holdings. Japan’s
Ministry of Health, Labor and Welfare announced earlier this
year that about 75% of nearly 600 pension funds in Japan
set up by small businesses in sectors like transportation,
construction, and textiles didn’t have enough assets to cover
expected payouts. Aviva, the UK’s largest insurer and one
of Europe’s leading providers of life and general insurance,
estimated that the European pension gap between assets and
liabilities stands at €1.9 trillion across the 27 European Union
member states.
Meanwhile, there have been 20 new sovereign wealth funds
created just since 2005 according to the SWF Institute, with
many of these entities looking to diversify state revenues in the
wake of surging gas, oil, and other commodity prices. These
organizations are looking at broad investment portfolios and
are showing an increased interest in both alternatives and
hedge funds.
These structural issues, along with low global interest rates
and low equity market returns in recent years, are likely to
drive participants to continue expanding their portfolios
into alternatives and hedge funds. As discussed in Section
II, the level of interest in hedge funds could even accelerate
if investors begin to move toward the risk-aligned allocation
approach that places hedge funds in the core as opposed to
the satellite portion of the investor’s portfolios.
Many of the participants we interviewed, particularly those
that have been in the markets for a decade or more, discussed
either recently having increased or planning to increase
their overall allocations. There were also a number of new
institutions that had either just begun or were on the cusp of
beginning their hedge fund programs. This was true across
the US, Europe, and Asia.
Another Massive Wave of New Capital Could
Be Forthcoming
While a minority of participants worried that near-term hedge
fund performance could endanger future institutional flows,
others pointed toward broader macro trends as driving the
opposite — a resurgence of active inflows that could rival the
wave of money seen in 2003-2007. This was based on a belief
that we are close to completing the massive deleveraging that
began in 2007-2008, and that a renewed focus on risk assets
will benefit the hedge fund industry and encourage investors
to increase their allocations.
If we use the actual 5-year growth rates registered by each
institutional segment between 2006 and 2011 and extend
those forecasts to the next 5-year window, projections about
a potential wave of new money can be supported.
Chart 20 shows the breakdown of such analysis. The starting
point in terms of overall assets is the same as in our earlier
projection and is based on the average increase in total assets
by segment between 2006 and 2011; but instead of going back
and using the 2006 level of interest for alternatives and hedge
funds, we will use the change in allocations between 2006 and
2011 and apply that going forward to reflect continued growth.
“ The timeline of judging performance for public pensions is
long term. Yes they look at quarterly results, but they are
keenly focused on the long view,”
- $5-$10 Billion AUM Hedge Fund
“ The biggest growth will be in private alternative products,
since developed Asian countries are aging rapidly; their
pension systems need to get more aggressive in allocating
to hedge funds and other alternatives,”
- $1-$5 Billion AUM Hedge Fund
“ We’ve been in a massive period of deleveraging since 2007-
2008. At some point in the coming period—call it 20XX—we
will see risk assets bottom. From there, growth assets will
kick in and we’ll see risk come back into the system,”
– <$1 Billion AUM Hedge Fund
“ There is still a lot of room for growth in the aggregate
demand for hedge funds. The highest allocation of our
clients is at 20%, but we have lots of clients that are only
at 1%-3% and they could grow to 10%. That’s a multibillion
opportunity per client,”
– Alternatives-Focused Consultant