Institutions More Comfortable With Hedge Funds

Mar 21 2007 | 12:11pm ET

Institutional investors are increasingly at ease with hedge funds. According to a new survey from State Street Corp., more than half of respondents say their boards are more comfortable with hedge funds today than they were a year ago. And that comfort level is having an effect on where they put their money: This year’s study shows some 56% of those polled invest with more than 10 direct managers, up from 48% in 2005. Just 4% of institutional investors have no hedge fund exposure, down from 16% the previous year.

By contrast, institutional investors are increasingly wary of funds of funds, with nearly a third saying they use none and just 8% using four or more. In the previous year’s study, those numbers were just over a quarter and 29%, respectively. The number of institutions using between one and three funds of funds soared to 60% from 43% in 2005.

All of the participants, which included global corporate pension plans, public plans, foundations and endowments, allocate to private equity.

“Investment boards are increasingly accepting that hedge funds are a viable option for their investment allocations,” said Gary Enos, executive vice president of State Street’s alternative investment services group. “They’re also discovering the various ways hedge funds can be incorporated into portfolios based upon investors’ risk appetite, return targets and overall investment objectives.”

All this is not to say that institutional investors aren’t worried about the headlines trumpeting the latest hedge fund collapse. More than half of investment boards are spending at least 15% of their time discussing hedge funds, and half say the negative publicity has sparked a call for more robust risk management programs. But investors expect those initiatives to come from hedge funds: Almost half called for additional reporting, analysis and stronger due diligence programs on the part of hedge funds, but less than 5% plan to boost their own staff levels to address the concern.

The bottom line worries them too, as in, a bottom line being eroded by rising fees. Nearly a third called high fees offsetting returns the biggest threat to hedge fund investing.

“As fees continue to eat away at precious returns, more institutions will balk at paying ‘alpha’ fees for ‘beta’ performance,” Jane Tisdale of State Street’s absolute return strategies group said.


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