Greenwich: institutional interest in hedge funds is here to stay

GREENWICH, CT -- Institutional investors’ growing attraction to hedge funds and other alternative investment vehicles reflects an overall change in investment strategies, and won’t be significantly altered by upswings in equities markets.

This is the gist of a recently published white paper, The price of success: hedge funds prepare for an influx of assets and attention by Greenwich Associates, in which the consultancy asserts that hedge funds should expect pension funds and other institutional investors to allocate more assets to them over the next few years, although they need to prepare for the more stringent reporting and disclosure requirements to accompany that capital.

According to John Webster, managing director at Greenwich, recovering equities markets in which institutional investors have long participated (and were stung in recent years) aren’t likely to have much of an impact on this scenario.

"A recovery in equities will affect institutions’ interest in hedge funds, but I’m not sure it will be a terminal impact," Webster says, adding that some institutional investors have used hedge funds in their investment strategies for years. "Within the firmament of investors that we’d consider as being institutions, the endowment and foundation group has been very much in the vanguard of investing in hedge funds. The idea of absolute returns, particularly when you’ve got a foundation that must distribute a percentage of its assets on a regular basis to keep its tax charitable status, has been appealing."

For corporate pension funds, Webster notes that liability issues are likely to keep them engaged with hedge funds -- the number of US corporate funds investing in this space increased from 11% in 2002 to 19% last year. "Even though their assets have levelled off, their liability situation has not because interest rates are down," Webster says. And, he adds, many of these institutions have bought strongly into the idea that hedge funds can provide stronger returns regardless of how equities are performing, indicating a shift in overall investment strategies. "There is the belief that, rightly or wrongly, a hedge fund can still yield good returns over and above conventional long-only domestic equities," he notes. "Data for 2003, however, suggests two-thirds of hedge funds trailed the Standard and Poor’s 26% gain."

Public pensions, however, pose a more challenging scenario, but Greenwich hardly expects them to avoid the hedge fund bandwagon -- 17% of US public pension funds currently invest in hedge funds, up from 8% in 2002. The major challenge here, according to Webster, is the issue of transparency: "On the public pension side, this issue will be something of a dampener on ultimate take-up. Public funds are honour-bound to disclose assets and holdings to the public, and that information can get out of professional circles and into a wider arena."

While hedge funds willing to take on institutional investors are likely to have to retool their reporting systems to meet client demands, Webster believes the bigger task for them will be accepting requirements for more transparency to begin with.

"Hedge funds are good at their own internal reporting -- they need to be acutely aware of where their positions are, and of intra-day risk," he says. "I don’t think they’re used to external reporting -- what cuts it for high net-worth individuals won’t cut it for institutions, so some degree of quarterly or monthly reporting will have to evolve, along with valuations on a regular basis. More front-end reporting will be required."