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Hedge Fund Survey: Institutional Investors Looking to Alternatives

New York (HedgeCo.net) – Institutional investors across the globe are demonstrating significant demand for alternatives to support investment objectives such as diversification and alpha generation, and these expanding allocations are spurring greater interest in customized, investor-driven implementation approaches, according to the 2012 Global Survey on Alternative Investing released by Russell Investments.

“Since 1992, the Russell Global Survey on Alternative Investing has provided an important view into the changing nature of institutional perspectives regarding alternative investments,” said Julia Cormier, director, alternative investments. “In an environment characterized by low returns, a high level of global economic uncertainty and financial market volatility, alternatives are a critical component of a diversified, multi-asset portfolio. In expectation of continued volatility and market shocks, institutions are trying to shepherd their portfolios by structuring them to prudently manage risk, even as they also seek to achieve returns in a variety of potential market environments.”

Institutions participating in the Survey currently have significant allocations to alternative investments – on average, 22% of total fund assets. Diversification was cited as one of the top three reasons for using alternatives by 90% of respondents, while volatility management and low correlation to traditional investments was mentioned by 64%, and return potential was noted by 45%. Additionally, the majority of respondents indicated that allocations would remain static or increase over the next one to three years across all alternatives categories. Thirty-two percent of respondents expect to increase their investment in hedge funds and private real estate, 28% in private infrastructure, 25% in private equity, 20% in commodities, and 12% in public real estate and public infrastructure.

“Alternatives can play a unique role in helping organizations achieve their desired investment outcomes, and in today’s dynamic alternative investment marketplace, institutional investors are using alternatives in multiple ways. At the same time, the factors that influence institutional investors as they evaluate and make decisions about alternatives continue to evolve,” said Darren Spencer, director, alternative investment consulting, North America. “With greater experience and expanding allocations, investors are increasingly driving implementation approaches. Today there is greater appetite for customized solutions in which investors can target specific risk/return outcomes, achieve more targeted strategy exposures, and be more opportunistic with their investments. This kind of fundamental shift in alternative investment implementation can provide a rich source of portfolio flexibility.”

The Survey also found that investors face a myriad of challenges in assessing the range of alternatives across the expanding spectrum of opportunities, so education is an important component for integrating alternatives into multi-asset portfolios.

Headline global findings:

  • Under-target alternatives could potentially be recipients of excess cash in the future. Hedge funds and private real estate lead the way, with 32% of respondents indicating that they may make increased allocations. At least 30% of respondents indicated they were below their target weights in hedge funds, private real estate and private equity, while traditional investments – cash, fixed income and equities – were more frequently over their target allocation than under their target allocation. Cash, specifically, is over-target for 45% of respondents, which may indicate that they are being cautious about taking risk and waiting for the right time to reposition cash.
  • 49% of respondents who participate in hedge funds currently utilize the fund of funds structure approach. This is more than double the percentage of that for any other hedge fund implementation method, however, this year’s Survey shows that participants anticipate making shifts away from the traditional fund of funds model. Only 17% of respondents using hedge funds expect to be using this traditional structure for implementation over the next one to three years. While fund of funds vehicles are anticipated to lose ground, all other implementation methods are expected to gain. Additionally, 63% of Survey respondents are obtaining customized hedge fund solutions to complement existing exposures, pursue niche opportunities and access strategy-specific expertise.
  • Consistent with previous surveys, private equity (PE) is more prevalent in North American portfolios, although Europe is not far behind. Commitments to private equity are lower in emerging markets, Asia Pacific and Japan. The liquidity constraints of negative cash flows are making PE less attractive for Japanese defined benefit pension plans. In both North America and Europe, more investors are currently committed to small/medium buyout funds than to larger funds. Significantly, both North American and European investors expect small to modest decreases in their current PE commitments over the next one to three years. Co-investments and alternative energy are expected to show the largest increases in commitments over the same time period.
  • Listed Real Estate Investment Trusts (REITS) and unlisted private real estate funds continue to dominate as implementation choices, with 51% of the respondents (who hold real estate currently) using them. Only 38% of these respondents, however, said real estate funds will continue to be an implementation choice in the next one to three years. Allocations to direct property investments (23%) and customized separate accounts (15%) are expected to rise in the near future.
  • Even with inflation-sensitive characteristics, commodities remain a niche solution and future possibility (more than a current reality) for most institutional investors – except in Australia, where commodities are familiar and mainstream. Among the small sample of Survey respondents who hold commodities (32 in number), long futures exposure is the most popular type of investment (63%), with private equity (44%) and hedge funds (28%) trailing. Long/short strategies and funds have not yet made much of an impact (23%), but interest in them is rising, with 46% of current commodity investors expecting to add long/short over one to three years.
  • Although public and private infrastructure investments command only a small share of institutional assets (just 1% of the combined asset allocations of all respondents), many signs point to growth. Private infrastructure investments appear to be attracting a growing portion of institutions’ illiquidity budgets, perhaps taking share away from private equity. Although Australian and Canadian respondents have higher allocations here, the other regions represented in the Survey have not yet made significant allocations to this segment.
  • Boards and trustees are demanding more education about alternatives and are becoming more receptive to proposals that have education included as a component. Given the dynamic nature of the alternative investment marketplace, 36% of respondents indicated that additional education about alternatives is needed within their organizations.
  • Russell has observed a growing respect among North American (NA) investors for comprehensive due diligence since its 2010 Survey. In the 2012 Survey, 91% of NA investors said they require comprehensive operational due diligence before making new investments (vs. 68% globally). Responses to this line of questioning signal a trend in institutional investors’ approach to working with external resources. Even some sophisticated investors have decided that they could better achieve their investment objectives by combining the expertise of internal and external resources to manage multi-strategy alternatives.

About the Survey

The Russell Investments’ 2012 Global Survey on Alternative Investing was developed to assess the primary factors that influence institutional investors as they evaluate and make decisions about alternative investments, within the context of their objectives for their institutions. The biennial survey, which was first issued in 1992, targets the largest corporate and public defined benefit plans, corporate defined contribution plans, non-profits and superannuation funds. It is delivered in an objective format, and respondents are asked about their views and methodologies concerning alternative investments.

Between January and March 2012, 146 institutional investors in North America, Europe, Australia and Japan representing a total of $1.1 trillion in assets completed the online survey. Many respondents also participated in longer qualitative interviews that captured evolving changes in philosophies, policies, allocations and attitudes. In this year’s survey, questions were developed around the following perspectives: assessing the demand for alternative investments, defining barriers to investing in alternatives, understanding key influencers and gaining insight into key implementation issues.


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