Where are all the assets going? Into the hedges

Hedge fund assets are expected to more than double to $5 trillion over the next five years, thanks to two major trends involving alternative investments.

A new report from Citigroup Inc. points to the increased use of alternatives by institutional investors and increased competition between alternative and traditional asset management firms as leading drivers in the growth of hedge fund assets.

While many pension funds, endowments, foundations and other institutional investors already have embraced alternatives for risk management strategies, the report projects a sharp rise in their use of alternatives over the next few years.

“We see a second wave of institutional allocations to hedge fund strategies, as well as new allocations to long-only strategies managed by hedge fund firms,” said Sandy Kaul, U.S. head of business advisory services at Citi Prime Finance.

According to Mr. Kaul, that “first wave of institutional assets to alternatives” unfolded between 2003 and 2007 when more than $1 trillion was allocated to alternative strategies.

That urge in appeal at that time can be tied to institutions’ desire to emulate the major investors, such as Yale University, were able to lessen the blow of the 2000-02 market downturn by hedging some of the risk associated with traditional portfolios of stocks and bonds.

Analysts at Citi Prime Finance predict that institutional investors’ focus on risk management will spark a new and wider interest in alternatives.

“While institutions haVE been allocating to hedge funds for years, such investments were considered to be on the periphery of core portfolio holdings,” said Alan Pace, head of Citi Prime Finance.

“That is no longer the case,” he added. “Today, with investors more focused on risk alignment within the overall portfolio, hedge fund allocations will play a central role in institutional portfolios in the years ahead.”

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