Compared to other alternative assets, hedge funds are relatively liquid investments and are typically added to investment portfolios by institutional investors in order to diversify, add a liquid source of alpha and tap into new sources of returns. A recent Preqin study of over 100 institutional investors has revealed that 32% of investors make 2-3 new hedge fund investments per year while 20% typically make 4-5. This indicates that there is the potential for thousands of new allocations to be made each year from the institutional market. As a result it is important that fund managers understand what their investors are looking for in order to take advantage of these new allocations.
Institutional investors have a number of methods of sourcing new hedge funds with a large proportion (41%) utilising a consultant to assist with fund selection. Thirty-eight percent of investors indicated that they prefer to receive proposals directly and the same percentage also source managers through networking and conferences. Other investors utilise databases, cap intro teams and third-party marketers to source funds and so it is important that fund managers utilise as many sources as possible when marketing their funds to an institutional audience. Two-thirds of investors allocate capital up to six months from the first time they view a fund although more cautious investors can take more than 18 months to mull over a potential investment. Investors with larger investment teams are more likely to be able to make a quick decision regarding a potential investment and these investors are also more likely to make regular changes to their portfolios in order to take advantage of opportunities in the market. Key factors for investors when assessing fund proposals include returns, source of returns/strategy, liquidity profile, track record and management experience/background.
Twenty-seven percent of investors add new hedge funds to their portfolios every six months with the majority (78%) adding new investments in every 18 month period. The figures are similar for the redemption of investments in hedge funds which indicates that most investors regularly redeem and replace managers in their portfolio. The survey indicated that the most common reason for investors redeeming from a fund was unsurprisingly due to performance concerns with 39% of investors likely to make a redemption for this reason. Ongoing performance issues affecting the asset class in recent years have increased the scrutiny on fund performance and many investors are now looking at this in more detail. Twenty-eight percent of investors cited other aspects of the fund as a reason for redeeming including factors such as strategy drift and overuse of leverage.
This study has indicated that institutional investors are now giving more scrutiny to their hedge fund portfolios and many make regular changes to their portfolios in order to enhance returns. This means that there should be plenty of opportunities for fund managers to achieve mandates over the coming year although they will have to ensure that they meet investor demands in order to hold on to these investors over the longer term. There are plenty of exciting opportunities for hedge fund managers due to the dynamic flow of institutional capital providing these managers can convince investors that they can provide strong returns.