The underfunding of pensions is leading to an increasing institutional interest in hedge funds and funds of funds as pensions seek more alpha at lower fees, according to a recent report from Infovest21.
Some of the biggest public funds in the US are increasing their direct allocations to hedge funds specifically, which Infovest21 says usually charge lower fees, provide greater transparency and outperform funds of funds. Massachusetts Pension Reserves Investment Management, one example of the trend, this year will shift $500 million into hedge funds out of the $3.5 billion it previously had allocated to funds of funds, directly allocating to hedge funds for the first time.
Other big pensions, including the Pennsylvania Public School Employees Retirement System, Virginia Retirement System, The Teachers Retirement System of Texas, New York State Common Retirement Fund and the Texas County & District Retirement System, are 100% invested directly in hedge funds, according to the research firm.
Hedge funds are shifting away from being part of an alternatives bucket to being considered a liability hedge, an inflation hedge or an alpha generator, the firm says. Pension plans are tagging alternatives/hedge fund allocations to both fixed income and equity replacement, whereas in the past, hedge funds were usually used as absolute return, according to the report. Pension plans are now moving assets from fixed income and equities into hedge funds.
The firm says pensions are also searching for structural efficiency, seeking to obtain better fees at the manager and portfolio construction level. To achieve this, Infovest21 says, some pensions are allocating directly to hedge funds, accessing fund managers at a reduced fee and/or combining replication strategies. Others combine long-only managers with hedge fund managers, which usually charge lower fees for the alpha they generate.
Other trends for hedge funds in 2011 and beyond include further regulation and an improving but challenging asset-raising environment.
Hedge fund assets worldwide were estimated to be $1.91 billion at the end of 2010, slightly up on the peak figures at year-end 2007 ($1.87 billion). Net new capital increased $13.1 billion in the fourth quarter last year, according to Infovest21, which was the greatest amount recorded in a single quarter.
However, While launches are increasing from the past few years doldrums, new launches tend to be relatively small in size, according to the report. The largest launches are considerably smaller than in early to mid 2000s.
The report is available from Infovest21 here.