investors account for 25% of the hedge market, up from 5% in 1993
Hedge funds are becoming an increasingly popular investment alternative for pension fund managers.
Institutional investors now account for 25% of the hedge fund market, up from 5% in 1993, according to Stephen Oxley, senior investment consultant at Watson Wyatt.
But it is uncertain whether demand for these higher risk products will continue to increase, Tony Osborn-Barker, head of investment services at Deloitte & Touche, said. High profile cases of pension funds failing to live up to expectations could mean that trustees become more conservative.
He said: 'Following the Unilever/Merrill Lynch case, many pension funds may be looking at cutting their risks rather than taking on more.'
Osborn-Barker points out that trustees have been given more flexibility to invest how they want which means that there are fewer barriers to stop them investing in hedge funds. But he stresses that this is being limited by the new constraints that are being imposed. He said: 'Increased freedom from the relaxation of the Minimum Funding Requirement is being countered by the imposition of the accounting standard FRS 17. This puts a short-term target that trustees have to aim at, I think it is difficult for trustees because they have multiple targets to hit with the same arrow.'
The nature of hedge funds will also limit the extent to which they are invested in by pension funds, according to Oxley. The fact that their different strategies are complex and hard to understand means that they are very heavy on governance resources, Oxley said.
Osborn-Barker pointed out that the use of hedge funds required a much more thorough research process, which may be an additional cost to pension funds who are under pressure to keep consultancy fees as low as possible.
Hedge funds are now better at providing information which pension fund trustees need when putting together a portfolio that has an appropriate level of risk, according to Osborn-Barker.
He said: 'The industry is now much more comfortable talking about the risk controls it uses and they're happier to be pigeon-holed about what style they run their money in.
High fees are another factor that puts trustees off hedge funds, Oxley said. He said a typical annual charge of 2% on top of a 20% of performance fee is higher than pension funds are used to. He said: 'Add this to the fund of funds fee of 1% and 5% ' 10% of the performance and the expense needs to be carefully against the expected benefits.'
A lack of investible indices is also a problem. Oxley said it makes benchmarking next to impossible. This means that several different performance measures must be used, as well as a softer approach to monitoring.
Another problem highlighted is the fact that many hedge funds have limited capacity. Some of the best performing funds with highly profitable niche funds may close with less than $200m, according to Oxley. He said: 'This means that managers with the longest and best track records tend to be closed to new investors, so finding good managers with whom to invest is increasingly difficult.'
This also means that the best managers can afford to exclude those investors they perceive as too demanding, said Oxley.
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