Institutions Committed To Hedge Funds Despite Falling Returns

Jul 1 2008 | 6:16am ET

Drawdown? What drawdown? Last year's downturn in hedge fund performance has not deterred institutions from investing in the asset classes, according to research from Greenwich Associates and Global Custodian.

The share of hedge fund capital provided by institutions was unchanged from 2006 to 2007, following several years of steady growth. Nevertheless, pension funds, endowments and foundations remain strongly committed to the asset class, directly providing 13% of the average hedge fund's assets under management and an additional 23% via funds of funds.

“High-net-worth individuals and family offices remain the biggest sources of assets for the average hedge fund, accounting for 37% of the total, which does not include about 10% of assets provided by the funds' employees and general partners,” said Greenwich consultant John Feng.

Institutional investors have overtaken high-net worth individuals and family offices as a source of assets for the world's biggest hedge funds. Twenty-five percent of these funds' assets come from direct investments by institutions, while high-net worths and family offices account for 22% of assets. In terms of importance to funds with more than $1 billion in assets, both of these sources rank behind funds of funds, which provide 27% of total assets, up from 25% a year ago, according to Greenwich.

In the U.S., which accounts for the vast majority of global institutional hedge fund investment, nearly 45% of institutions invest in hedge funds, which had grown to represent 2.6% of institutional assets as of 2007—up from 2.2% in 2006 and 1.9% in 2005. Although those percentages seem modest, when converted to dollar terms U.S. institutions' investments in hedge funds totaled some $195 billion in 2007, up from $140 billion in 2006 and $113 billion in 2005.

Twenty-three percent of U.S. institutions said they planned to increase their allocations beyond current levels by 2010; only 2% said they planned to reduce them. Feng noted that average allocations at the country level include many institutions that do not invest in hedge funds at all. “Many active hedge fund users have devoted much larger shares of their assets. For example, U.S. endowments that describe themselves as active hedge fund investors devote on average 16.5% of their total assets to hedge fund investments,” he said.

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