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Both Large and Small Foundations Remain Key Investors in Hedge Funds – May 2014

by Brian Orlay

  • 15 May 2014
  • HF

Foundations are substantial investors in hedge funds, with Preqin’s Hedge Fund Investor Profiles online service revealing that hedge fund allocations from foundations account for approximately 8.4% of all institutional capital invested in hedge funds globally. Foundations comprise approximately 20% of all active hedge fund investors tracked by Preqin and these vary in size; 85% of foundations have assets under management (AUM) of less than $1bn.

Even though larger foundations are outnumbered by their smaller counterparts, 72% of total foundation AUM and 68% of assets allocated to hedge funds by foundations are represented by those foundations with at least $1bn in assets. The average allocation to hedge funds across all foundations is 17.8% of total assets, with larger foundations (those with at least $1bn in assets) allocating an average of 16.2% and smaller foundations (those with less than $1bn in assets) allocating an average of 18.1%. The minority of foundations with AUM at or above $1bn control the vast majority of hedge fund assets, while maintaining a smaller average allocation to hedge funds overall.

Over 85% of both larger and smaller foundations are located in North America (87% and 93% respectively), with most of the remaining foundations based in Europe. Smaller and larger foundations have similar preferences when it comes to investment strategies and geographical exposure. Long/short equity, multi-strategy, event driven and distressed are the most utilized investment strategies by both sizes of foundations. North America is the most prominent region (with 89% and 82% of small and large foundations indicating a preference respectively) and both have similar preferences in terms of exposure to Europe and Asia-Pacific. However, larger foundations are nearly twice as likely to allocate to emerging markets as smaller foundations, with 44% and 26% indicating a preference for emerging regions respectively.

Larger foundations are more likely to invest in hedge funds directly through single managers than their smaller counterparts, with 88% investing via this method, compared to 61% of smaller foundations. Smaller foundations prefer investing through commingled funds of hedge funds, with 62% of them investing in the fund structure, compared to 50% of larger foundations. Larger foundations have more capital and larger investment teams that can deploy and diversify a single manager hedge fund portfolio, while smaller foundations are more likely to outsource investment management and seek diversification via funds of hedge funds. For similar reasons, larger foundations are more likely to consider investing in emerging managers and spin-off teams, with 48% and 52% of larger foundations willing to consider these firms respectively, compared to 23% and 24% of smaller foundations.

The $1bn demarcation between larger and smaller foundations reveals a number of key differences between the two. Smaller foundations are more likely to allocate to lower volatility strategies and shy away from regions such as emerging markets, but typically have a greater preference for funds of hedge funds and on average allocate a higher proportion of total assets to hedge funds. Larger foundations have a greater preference for investing in hedge funds directly and are typically more willing to invest in riskier strategies. As the market for hedge funds continues to grow, and foundations both large and small continue to build out hedge fund allocations with many overlapping preferences, these investors will continue to be an important source of capital for the industry.

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