As hedge funds increasingly look to the institutional market for asset growth, they must equip themselves to fit the high expectations and conservative attitudes characterising institutional investors, concludes a white paper released on Monday by SEI, a provider of outsourced asset management, investment processing and investment operations solutions.
Hedge fund assets under management have been growing at a compound annual rate of 26% since 1990, with much of that growth coming from the institutional market, reports the white paper, entitled, 'Five critical challenges for hedge funds taking aim at the institutional market'.
"To maintain that growth trajectory, the hedge fund industry will need to branch out from its traditional high-net-worth and endowment clientele to serve the broader institutional market," says Paul Schaeffer, managing director, strategy and innovation, investment manager services division, SEI. "But to compete for those assets, the industry must recognise that large institutions have a distinct set of demands concerning issues such as the quality of infrastructure, transparency, and risk"” he explains.
Based partly on a survey of more than 100 institutional investors carried out by SEI and research firm Infovest21, the white paper details growing institutional acceptance of hedge fund investing. Forty-seven percent of the institutions surveyed said they already invest in hedge funds. Within that group, 73% of pension plans and 55% of institutions overall said they had increased hedge fund allocations over the last several years. Portfolio allocations to hedge funds averaged 30% for endowments, 13% for pension funds, and 24% for institutions.
At the same time, institutions expressed continued concerns with hedge fund investing. Headline risk was named by 37% of survey respondents as their biggest worry, followed by lack of transparency (19%) and poor performance (15%). Institutions also remain cautious in selecting hedge funds, the survey found, devoting an average of seven months to due diligence and 12 additional weeks for approval.
In the paper, SEI identifies several challenges hedge funds should address in order to attract more institutional assets. First was demonstrating institutional-quality infrastructure and operations; second was meeting investor demands for reporting and transparency; and third was building stable management teams with a full range of skill sets. The report found that hedge funds need to shift their focus from performance to investment disciplines, and that it is vital for them to keep abreast of public policy and regulatory trends.
"The overriding message is that institutions clearly prefer to do business with institutional-style organisations," comments Schaeffer. "For hedge funds, the challenge will be to fit the profile of an institutional-quality fund while preserving the performance attributes that attracted major investors in the first place," he adds.