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Institutional Investment in Hedge Funds: Evolving Investor Portfolio Construction Drives Product Convergence
I
9
A massive wave of new capital entered the hedge fund market
in the following 5 years. Between 2003 and 2007, more than
$1 trillion in new money was channeled to the hedge fund
industry from institutional investors. This was more than
double the amount of flows noted over the previous 8 years,
as shown in Chart 1. Indeed, up until now the flows during
these years remain the largest single wave of money the
industry has seen.
The impact of this move, and the earlier change in allocations
from active to passive funds, are clearly evident in Chart 2. In
2003, institutional investors only had 7.0% of their portfolio
allocated to passive or beta replication strategies and 2.4%
allocated to hedge funds. The remainder of the portfolio
(90.6%) was invested with traditional active asset managers.
By 2007, a full 10% of the assets for these investors had been
allocated away from active managers. Passive mandates
received an additional 3% of the allocation to grow to 10%
of the total portfolio, while the hedge fund allocation grew by
nearly four times, to 9.2% of the total portfolio.
“ Institutionalization started around 2000 when people were
watching their long-only equity allocations post down 20%
and hedge funds were able to exploit heavy thematic trends in
equity markets and alternative forms of beta that clients didn’t
have anywhere else in their portfolio,
– Institutional Fund of Fund
“ Clients are selling their long-only equity funds to buy other
stuff. Everything from hedge funds to other stuff like real
assets—everything from commodities to real estate to
infrastructure deals. My guess would be that they’ve moved
10% out of their equities allocation with 5% going to hedge
funds and 5% to real assets,”
– Long-Only & Alternatives Consultant
90.6%
7.0%
Passive
$606B
Hedge Funds
$211B
2.4%
December 2003 $8.7 Trillion
December 2007 $13.5 Trillion
Chart 10
Active
7.8T
80.7%
10.1%
9.2%
Passive
$1.37T
Hedge Funds
$1.24T
Active
10.9T
Comparison of institutional aum pools by investment type
Chart 2: Comparison of Institutional AUM Pools By Investment Type
Source: Citi Prime Finance analysis based on eVestment HFN & ICI & Sim Fund data