Global Hedge Fund Industry Themes

"Making money doesn't oblige people to forfeit their honor or their conscience."

Baron Guy De Rothschild, banking magnate

Here are a list of investment industry themes that have taken firm root in 2006 and should continue to impact 2007.

1/ Quantitative specialists taking hold with pension investors (e.g. State Street, GSAM, BGI, Bridgewater Associates, AQR etc.)

2/ Liability management anchoring and diversification entering into more and more strategic asset allocation debates on investment committees around the world

3/ Institutional investors continue to prefer "best of breed" products and product providers.

4/ Private clients still showing a proclivity to "chase" performance in both the long-only or hedge fund worlds. This will impact fund raising.

5/ Explosive growth in ETFs (cheap passive investment vehicles) is not a fad.

6/ Aggregate performance of hedge funds still heading lower with returns on average coming in around the cash + 400-600 basis points range.

While not all doom and gloom for hedge fund industry it is interesting to note what the expected real returns and allocations are for one of the biggest and aggressive users of alternative investments. What follows is the strategic asset allocation recently made by a prominent Ivy League U.S. endowment:

• Real Estate 6% (exp. real return), 21% allocation
• Private Equity 12% (e.rr), 14% allocation
• Hedge Funds 6% (e.rr), 27% allocation
• Fixed Income 2% (e.rr), 10% allocation
• International Equity 7% (e.rr), 13% allocation
• US Equity 6% (e.rr), 15% allocation

Of note, the real return expectation and strategic allocation to "hedge funds" has come down substantially for this institutional investor over the last couple of years (they were as high as 40% in hedge funds not too long ago).

In its place, real estate, private equity, international equity and to a lesser extent fixed income look poised for higher allocations. Incidentially, another endowment sent a big contingent of its investment team to live in China for a big portion of the summer.

Another startling fact is the almost equal allocation to be made to international equities and U.S. domestic equities. Wow! Perhaps the recent downward action in the US Dollar is part of this unfolding equation...

Think about it for a minute. If only a fraction of the world's institutional investors re-arranged their allocations along similar lines what would happen to the prices and volatility of some of these asset classes? Of course, this is not a realistic thought as hedge funds do not comprise such a large portion of many investor assets...but it could nonethless suggest that titantic changes may be coming that should benefit hedge funds at least over the near term. More another time on the investment allocations and expectations of Japanese institutional investors.
Mahalo.