Alternative investing to be taken off endangered species list

13 July 2008

Last week, while JP Morgan CEO Jamie Dimon was busy attacking short sellers, his firm released the latest edition of its annual institutional investor survey.  Given recent events both inside and outside the hedge fund sector, it makes for a fascinating read.  The summary results of the report, “Next Generation Alternative Investing” are available here with a quick and free registration.

Much as an animal is removed from the endangered species list when its numbers multiply, the report concludes that alternative investments may soon out-grow that moniker.

Says the summary:

“The survey confirms that these strategies—now established components of many institutional portfolios—are no longer “alternative” at all. In fact, alternatives now play an essential role in institutional portfolio strategies, and we expect across-the-board allocation increases despite recent market turmoil.”

Notably, this year’s survey included questions on portable alpha and 130/30 strategies (appropriately, we might add, discussed in the same breath).

What is probably most striking about these findings is that the popularity of alternative investments is pegged to grow over the next 3 years despite market mayhem (that has led to the worst first half for hedge funds since 1990).  As the report points out, some of this increased demand is a result of market mayhem itself.

As the chart at right shows (click on it to view), demand for hedge funds is expected to increase by 25% over the 2007-2010 time period.  The report also finds that 40% of asset flows into alternative assets will go to hedge funds over the next three years.

The report goes on to say that over 50% of respondents said they planned to increase hedge fund allocations in the next three years while only 7% said they would decrease allocations.

About a quarter of respondents said they were currently using 130/30 strategies.  That’s pretty high when compared to other recent surveys on the topic (see related posting).

In the clearest sign yet of the ”next big thing”, JP Morgan places “green investing” on the chart (below) with portable alpha and its successor 130/30.  (Note the number of respondents in this asset class is set to nearly double over the next 3 years) 

Who’s driving the green express?  Public pension plans.  Their reputation for more innovative strategies (such as portable alpha) seems to be conspiring with their slightly more social mandates to make this category of investors particularly predisposed to green investing.

Are investors happy with returns?  Well, it depends who you ask.  As the chart at right shows (click on it to view), public pensions are most pleased with real estate returns and least pleased with the returns of their private equity funds.  Corporate pension plan, on the other hand, are equally pleased with real estate, but not wit their hedge funds.  Endowments and foundations share this concern about hedge fund returns, but say that they are most pleased with their allocations to “absolute return” strategies in general.

Finally, on the topic of fees, the report observes:

“While fees are not cited among the top investor concerns, there is clearly emerging pressure on fees. Investors believe that fees are fair as long as performance expectations are met, which should be a red flag to managers that there could be a backlash on fees, or a greater demand for performance-based fee schedules, should performance start to lag expectations.”

This report is timely because it reminds us that, despite some inevitable performance-chasing, there are fundamental trends driving the move to alternative investments.  So fundamental it seems, that alternatives may soon cease to be alternative at all.

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