Despite relative outperformance, still room for alternative investments to grow.

25 Mar 2009

Some have suggested that the strong performance of hedge funds relative to equities over the past 12 months could come back to haunt it in a rather circuitous manner.   The theory goes that institutional investors with fixed target allocations to different asset classes might decide that alternative investments now represent too large a portion of their holdings – simply because alternatives depreciated much less than equities over the past year.

That was the theory.  But a report from consultancy Casey Quirk and institutional investment database eVestment Alliance says that hedge funds represent the same portion of institutional portfolio allocations now as they have over the past few years.  In fact, institutional allocations to alternative investments (of all sorts) have remained pretty stable at around 3.5% since way back in 2004.

The report also contains some other interesting observations about the greater asset management industry.  For example, check out the chart below showing the average allocations to equities, fixed income and alternatives by type of institution (click to enlarge).

Notice the whopping, what, 3% allocated to alternative investments by endowments and foundations.  Defined contribution pension plans also have a statistically significant allocation to alternative investments.  But almost across the board, you can see that there is significant growing space for alternatives – particularly if, as one commentator has recently predicted, “equities are dead as a long-term asset.

And here’s a curious observation.  While new asset flows into all funds tracked by eVestment Alliance was around US$600 billion/year until Q4 ’07 (chart not shown here), annual asset flows from institutional investors turned negative at least a year earlier (Q4 ’06 or before, it’s impossible to tell from that chart – click to enlarge).

This means that institutional investors were decidedly counter-cyclical.  As retail investors piled into funds in 2007, institutions were apparently stampeding for the exits already (to be joined by retail investors at the end of 2008 – just as the institutions started getting back in the game again).

This quarterly update on the state of the asset management industry is pretty interesting.  We’d recommend it for anyone who makes it their business to keep tabs on the waxing and waning of the investment management sector.

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