Investors to increase hedge fund allocations, according to Deutsche Bank survey

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24 Feb, 2012

Institutional investors could allocate up to $140 billion to hedge funds in 2012 bringing total industry assets under management (AuM) up to $2.26 trillion, according to Deutsche Bank’s latest Alternative Investment Survey.

This is despite the average hedge fund losing 5% in 2011 in what was only the industry’s third down year since 1990. Institutional investors, particularly pension funds, are increasingly warming to alternatives. In 2011, 80% of investors surveyed either grew or maintained their existing allocations into hedge funds while 25% are seeking to bolster their investment teams. Institutional capital now accounts for two thirds of total hedge fund assets compared with just one fifth in 2003.

Anita Nemes, global head of capital introduction, said these strong figures were a bullish endorsement of the hedge fund industry.  Many commentators reckon hedge funds will increase their $2 trillion total AuM or even surpass its $2.04 trillion record.

“Generally speaking, hedge funds are returning to asset levels similar to those in the mid 2000s.  Despite the downturn, hedge funds are rebounding and numbers are returning to normalised levels,” commented Michael Terry, global head of cap intro at Bank of America Merrill Lynch (BofA).

Performance continues to be the key driver behind capital allocations with 80% of respondents ranking it as one of the top five most important factors.  Fees were also cited as a very important issue by 10% of investors, compared with just 1% in 2002. The survey said 51% of respondents had negotiated fees during the last 12 months.

Research in 2011 by Preqin said the average hedge fund management fee stands at 1.6% while performance fees are 19.2%. Figures coming out of Hedge Fund Research suggest management fees are at 1.58% while performance fees stand at 17.04% - the lowest figures since 2003.

“Fee pressures are mounting so it is essential for managers to keep expenses below a fixed rate. There continues to be give and take among investors and managers. Interests are becoming even more aligned. Large investors often demand lower fees and frequently get them. For managers with a stable base of assets and recurring management fee revenue, a lower management fee in exchange for a higher incentive fee based on performance can be tolerable and even favourable,” said Ron Suber, senior partner and head of global sales at Merlin Securities.

The survey also revealed that funds of hedge funds (FoHFs) continue to play an important role alongside consultants. “These participants will continue to provide discretionary assistance and advisory services to both new and experienced institutional investors. Together, they made up over two thirds of respondents in this year’s survey by AuM, further proof of their increasing importance,” said the survey.

Consolidation too will continue with larger funds getting even bigger. Some 44% of respondents are invested in managers with more than $1 billion AuM while a third intend to allocate to $1 billion plus managers over the coming year.

This should not come as a shock. Citi Prime Finance calculated the 13% of managers with more than $1 billion AuM control the overwhelming majority of the $1.7 trillion in total investor capital. Pension funds, sovereign wealth funds and insurance companies often have tough risk controls and binding concentration limits thereby preventing them from allocating to boutique organisations. A survey of institutional clients by JP Morgan reveals 43% of investors writing $250 million plus tickets will not consider a manager that is sub-$1 billion AuM. This flight to larger managers has predictably disadvantaged start-up hedge funds as only 17% of investors nowadays provide seed capital whereas 53% did 10 years ago, according to the Deutsche Bank survey.

Investors’ ongoing love affair with managed accounts shows no sign of waning with 42% already using these vehicles with another 23% intending to do so during the course of 2012. “Transparency, ownership and liquidity” are cited in the survey as the most attractive benefits of managed accounts.

“When thinking about the advantages of managed accounts, they offer better corporate governance, enhanced operational infrastructure and independent risk management, which is all incredibly valuable,” said Patric de Gentille Williams, chief operating officer at Financial Risk Management’s seeding division Financial Capital Advisors.

Deutsche Bank surveyed 400 investors worldwide, with more than $1.35 trillion in hedge fund assets. Respondents included public and private pension funds, foundations and endowments, government organisations, FoHFs, private banks, investment consultants and family offices.

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