On Wednesday, State Street released the findings from its survey of institutional investors at October’s Global Absolute Return Congress (“Global ARC”) in Boston. The firm surveyed pensions & endowments that they say were collectively responsible for US$1trillion of assets. Unlike a similar industry survey conducted by Deutsche Bank in January, this one did not include funds of hedge funds. As regular readers may recall, we felt that aggregating data from funds of funds along with data from pensions & endowments (“end investors”) may have skewed the results. We can see some evidence of this by comparing the State Street and DB studies.
In our opinion, funds of funds are more likely to be unsatisfied with hedge funds than are end investors. The DB report suggested that investors were dissatisfied with hedge funds:
“…73% of investors worldwide report that they have had difficulty finding managers that live up to their expectations.”
Interestingly, when the same question was posed to only the end investors, the results were markedly different. Said State Street:
“…hedge funds got higher marks for increasing absolute portfolio returns this yearâ€”the ultimate testâ€”with 65% saying their hedge fund investments matched their expectations with regard to raising the absolute return of their portfolios (versus 57% last year).”
In fairness, States Street did find that end investors were somewhat less satisfied with the volatility and market correlation of their hedge funds. But the “unsatisfied” numbers were all far below 50%.
Other findings in the State Street survey include:
A higher percentage of respondents were users of hedge funds in 2006. While the proportion of heavy users (those for whom hedge funds represented over 10% of their portfolios) remained constant, the number of casual users jumped from 40% to 52% of the respondents. In contrast, the proportion of respondents who said they have never inhaled dropped from 16% to only 4%. No category was offered for habitual abusers of hedge funds.
Respondents bought more single-manager funds and less funds-of-funds in 2006. It seems that the pundits at Managed Accounts USA may have been right – funds of funds are getting the squeeze. Over half of institutions in this survey owned 10 or more single manager funds in 2006. Ironically, the number of respondents who used no single-managers at all also rose. State Street suggests this group of apparent fund of funds owners may just be new to the hedge fund industry – and may be following the common entry strategy of making a maiden investment via funds of funds.
Respondents were uncomfortable with basic due diligence issues. Amazingly, nearly two thirds of respondents believed that accurately valuating their hedge fund holdings could be problematic. An astonishing 53% of respondents said their fund’s general partner was solely responsible for valuation and 47% (probably a subset of the 53%) said there was no independent administrator for one or more of their funds. Only 20% believed that a lack of SEC registration was a problem (although SEC registration sure would have ended most of those valuation and administration concerns).
Fees are too high (sort of). Contrary to assertions by some hedge fund managers that hedge fund investors are not fee sensitive, a third of respondents in this survey said they were concerned that “fees are so high they offset investment gains disproportionately”. This is a curious way to ask this important question and we’re not sure what to make of it. But whatever it means, it sounds worse than simply offsetting gains proportionately we suppose.
Respondents also cited fees as one of the “greatest challenges” in the coming year. But despite serious due diligence issues and queasiness over fees, the #1 greatest challenge for the coming year was: “finding alpha“. (Reinforcing once again why we didn’t call this website “AllAboutDueDiligence” or “AllAboutFees”.)