GLOBAL - Institutional demand for hedge funds is set to triple to over US$1trn by 2010, led by pension funds seeking new asset classes to better match their growing liabilities, a report has claimed.
According to the study of over 100 clients by the Bank of New York (BNY) and Casey, Quirk & Associates, institutional investors will account for more than 50% of the total flows into hedge funds through 2010, with pension plans representing 65% of institutional flows.
Brian Ruane, executive VP at BNY, even described the $1trn figure as a "conservative" estimate of where institutional demand would be in 2010.
The report stated that cumulative flows from institutions would be around $510bn from 2006 through 2010. Broken down geographically, the US (36%), Europe (23%) and Japan (16%) were the largest players.
The survey also found that the median allocation of investors currently invested in hedge funds was likely to rise from 6% today to 10% by 2008.
Key drivers behind the projected boom were lower expected returns from traditional investments and a broadening acceptance understanding of alternative investment products and techniques in general, said Ruane.
“Institutional investors are increasingly recognizing that hedge fund allocations have provided significant diversification benefits while delivering the net returns they require.”
Given the growing importance that institutional investors are expected to play in the hedge fund market, David Aldrich, managing director at BNY, suggested many managers would need to shift their focus going forward.
"There are still a large number of hedge fund managers not yet interested in tapping institutional demand," he said. "They might get away with that today, but that will have to change going forward."
Despite the growing demand, there remained a number of issues that needed to be tackled going forward, namely fees, capacity constraints and skills shortages.
Aldrich said: "Capacity is a big concern, and there is already a shortage of talent available to investors. Good managers are a scarce resource today, even more so when you look at the projected growth in demand."
According to the report, institutions generally viewed hedge fund fees as high, but justifiable given the net returns.
"For institutions with direct hedge fund allocations, fees are virtually never a determining factor in hiring a manager, and are generally not negotiated," the report said, and added that management fees caused more concern than performance fees.
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