Approximately 48% of endowment plans active in the hedge fund space have indicated that they have invested or will consider investing in emerging manager funds. This compares to an industry average for all institutional investors of around 22%. Preqin’s Hedge Fund Investor Profiles online database tracks 581 endowment plans that invest in hedge funds; a well-established group in this asset class which, on average, made its first investment in hedge funds in 2001, and allocates an average of 18.8% of its assets to hedge funds. The majority of endowment plans are based in the US (94%).
Endowment plans tend to be long-term investors with the ability to tolerate more illiquidity from their hedge fund investments and accept higher lock-up periods than their institutional peers. In the absence of an established track record, endowment plans that allocate to emerging managers capitalize on niche investment opportunities and unique hedge fund strategies which are not always available from established managers. As such, endowments seek value from emerging managers and spin-offs as potential sources of enhanced hedge fund returns.
Investing with emerging managers is often perceived to be risky due to their lack of a track record and a general lack of experience, whereas spin-offs tend to offer more experienced industry professionals but, once again, a limited track record. The upside to taking on this risk is that investors may secure a rising star in the industry, locking in favourable fees and fund terms as founder share class investors. On the downside, these types of managers often lack the infrastructure to manage large amounts of capital and may also be implementing strategies that are relatively untested in different market conditions.
Endowment plans have a larger preference to invest with emerging managers and spin-offs when compared to other types of institutional investors. Endowments seek to maximize potential absolute returns and are willing to commit capital longer term given the right investment opportunity. Where damp hedge fund performance in 2014 was unable to hit +4%, emerging managers and spin-offs could benefit at the expense of more established managers.