Preqin to Hedge Funds: Wooing Institutions May Require Patience

Inflows are outpacing outflows for hedge funds thus far in 2012, “despite the global economy still experiencing great uncertainty…” says Preqin in the Foreword of its new Global Investor Report. It attributes to a Taiwanese insurance company an explanation of this fact:  “Despite our hedge fund portfolio failing to meet expectations, we will continue investing in them as we believe that hedge funds can still outperform traditional investments like equities and bonds.”

So Preqin is looking at its database of 3,400 in something of the spirit of a lonely hearts’ columnist, to find out what institutional investors want in a hedge fund, not just in the hedge fund industry generally but in the specific funds to which they do commit.

Nearly a third of the investors surveyed said that on average they made two to three hedge fund investments per year. A very few (two percent of those surveyed) said that they made more than 20. This means there is “the potential for thousands of new investments to be made each year” from that market.

Institutions aren’t to be rushed, though. The process can take more than a year. Preqin asked institutions: once a fund has caught their attention, specifically once they have first seen a fund proposal, how much time typically passes before they actually make an investment, if they do?

Only a third of the respondents said that the lapse of time is likely to be three months or fewer. Another third spoke of a four to six month courtship. The final third had longer intervals in mind.

But the length of the process depends upon the sort of institution involved.  Larger institutions (those with “the resources to make a decision quickly”) as well as those with a mandate for some speculative activity will often be more ready to allocate after only a brief interval: smaller or institutionally more cautious institutions less so.

Institutions, unsurprisingly, also concern themselves with liquidity, especially since many were caught in redemption suspensions or clanging gates in 2008.  Since then, even an investor with a long-run horizon generally wants the comfort of short lock-ups and redemption notice periods. Indeed, one measure of this is that 58 percent of institutional investors in hedge funds report that they make at least one redemption a year.

They also concern themselves with transparency. Preqin quotes a U.S. based public pension fund, “We’ve seen an improvement in the amount of transparency funds are offering us over the last few years. This is great news! If only the same could be said for fees.”

Plans for the Year Ahead

Preqin says that 70 percent of institutions in the database expect to allocate new capital to hedge funds over the next twelve months. Most of that will be invested opportunistically. Only 24 percent plan such new allocations within a unified target commitment.

These new capital infusions will be to a mixture of new managers on the one hand and managers with whom these institutions already have a relationship on the other. The allocations will also go to a wide range of strategies. Macro hedge funds are one popular choice, “with investors seeking to take advantage of currency movements, geo-political events and inflation and interest rate changes.” For example, the Korea Investment Corporation, the sovereign wealth fund of the Republic of Korea, is increasing its allocation to hedge funds, and “is searching for a diverse range of funds, including macro funds, for this move.”

Preqin breaks down the world’s investors in hedge funds into four regions: North America, Europe, Asia-Pacific, and the rest of the world.

By Region

In North America, endowments and foundations are the institutions most active in allocating to hedge funds. Many of the smaller foundations and endowments have only recently made their “maiden forays into hedge funds.”

In Europe, private sector hedge funds are the largest portion of the investor universe. Public sector pension funds, too, have demonstrated “their commitment to the hedge fund asset class over recent years.”

In the Asia-Pacific region, the “landscape is dominated by various forms of pension systems,” especially those of Australia and Japan. Japan in particular has a rapidly aging population, and the increasing liabilities have pressed the pension funds to increase their exposure to hedge funds.

The “Rest of the World” is – as one might expect from its definition – “widely diversified in terms of investor type.” Funds of funds play a big role, as do private sector pension funds, family offices, and sovereign wealth funds.

Since much of the “RotW” consists of emerging market countries, Preqin notes that the “nascent hedge fund industry in the region continues to develop and mature.”

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