Apparently it’s institutional investor survey season in the US.  Yesterday, Greenwich Associates released the latest findings from its on-going pulse-check of institutional investors. Although they seem to warrant their own headline in the firm’s press release, hedge funds top out at 2.1% of all institutional assets – up a whopping 0.1%/year for the past two years.  At least the proportion of institutions that invest in hedge funds has risen by more than that – from 29% in 2004 to 36% in 2006.

But Greenwich’s Chris McNickle says:

“The data suggest that institutional use of hedge funds will only grow in coming years. Twenty-two percent of U.S. funds expect to make significant increases to hedge fund allocations by 2009. Among public pension funds, more than 42% are planning significant increases to their hedge fund allocations.”

Meanwhile, private equity – which represented a relatively huge 3.8% of institutional portfolios – was referred to by Greenwich as an area of “chronic underinvestment“. The problem, according to Greenwich’s Will Wechsler, is capacity:

“Increasing actual allocations to target levels has proved a difficult task for most institutions. There is a lack of capacity relative to the amount of capital institutions would like to devote to the asset class, and where capacity does exist, it is generally outside of the relatively small number of fund managers that have historically generated the best and most consistent returns.”

Private equity managers seem to have more “return persistence” (i.e. the private equity market is less efficient than other more liquid markets).  This observation raises some interesting questions for the hedge fund industry. While there are a few storied hedge fund managers with long-term track records, studies show that “persistence” is low in that industry.  But is this lack of persistence actually the secret behind the hedge fund industry’s growth?  In other words, if a sub-set of managers produced consistently high returns, would the industry actually shrink?