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Funds of funds versus direct hedge funds: institutional investors undecided

by Amy Bensted

  • 01 Mar 2010
  • HF

Since the beginning of the year we have seen several institutional investors altering their approach to hedge fund investments – with many investors looking for new strategies and geographic regions to add to their hedge fund portfolios to capitalise on current opportunities in the market. Fund of funds arguably had the most difficult time after the financial crisis especially following their gating of assets, under-performance (relative to other fund strategies) and the high profile exposure of some multi-managers to the Madoff funds. As a result many institutional investors pulled their capital out of such vehicles in favour of investing in hedge funds directly. This trend has continued into 2010 with investors (such as South Carolina Retirement Systems) having announced recently to either redeem all fund of funds holdings or shift their portfolios in favour of direct investments. In South Carolina’s case the retirement system has been planning to redistribute capital towards direct investments since the end of 2008 with the final approval for a new 70/30 split between direct and fund of funds investments being made in January 2010. This move could see South Carolina invest up to USD 4 billion in single manager funds over the next 2 years.

Conversely, some investors have begun to re-allocate to funds of hedge funds. University of Missouri System Endowment has announced plans to redeem its holdings in single manager funds and to place the resulting capital in its existing funds of funds managers. New investors to the asset class are also continuing to do so through the fund of funds route, with Milwaukee County Employees’ Retirement System having recently hired two new long/short equity funds of funds as part of its initial foray into hedge funds.

The institutional consensus on fund of funds investment versus direct investments in hedge funds remains undecided. The fund of funds industry was dented following the market crisis – there has been a shift in the institutional market towards direct investment, although this is predominantly limited to the more experienced investors which are now looking to create their own portfolios of hedge funds. However we are witnessing new inflows of capital into funds of funds over the first quarter of 2010; some investors which were disappointed in the returns of such funds in 2008 and now once again adding multi-manager vehicles to their portfolios following stronger returns in 2009 and new investors continue to use funds of funds as the investment mode of choice when dipping their toes into the hedge fund waters.

Preqin monitors 791 institutional investors in funds of hedge funds – for more information on these investors as well as full profiles for 2,500 institutional investors actively investing in hedge funds please click here.

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