Venture capital funds are also oversubscribed as they raise funds that are 25% to 40% smaller than previous ones, noted Parag Saxena, managing partner of INVESCO Private Capital, New York. "Now, there are non-top-tier funds raising larger funds. … These managers are taking the money and raising the size of their pool," Mr. Saxena said.
For example, Golden Gate Capital, San Francisco, a 5-year-old private equity fund manager led by David Dominik, who was a managing director at Bain Capital, turned away billions when the firm raised its last fund, said Jeff C. Hammes, senior partner at Kirkland & Ellis, a Chicago-based law firm who represents Golden Gate.
Institutional investors are seeking to invest more and more money in private equity funds, Mr. Hammes said. "I see $1 billion funds who are getting $5 billion in commitments."
But most private equity fund managers are not risking their returns by collecting all the investment dollars that are offered, said Mr. Hammes.
"They're in an IRR (internal rate of return) driven business. They are looking to produce the largest IRRs," he said.
Some institutional investors who cannot invest as much as they would like with top-tier private equity and venture capital firms are investing in hedge funds and real estate funds, Mr. Saxena said.
"A lot of people are finding and going into hedge funds," Mr. Saxena said. "Overall the beneficiaries of the search for IRR are the hedge funds and to some extent real estate."
One reason getting into hedge funds will be somewhat easier is the likelihood of changes in global capital markets, which create opportunity for hedge fund managers, said Yanni Partners' Mr. Hammerstein.
"If market dislocations occur, like some of the major credit events of 2002, that creates great opportunities for hedge fund managers, especially those offering distressed debt or credit strategies," Mr. Hammerstein said. The more volatility in the market, the more capacity hedge fund managers tend to have, he added.
Since many institutional investors are making their hedge fund allocations through fund-of-funds managers, the issue of capacity becomes the intermediary's problem, sources said.
For bigger hedge fund-of-funds managers, those with more than $5 billion under management, capacity is usually not a problem, said Jeff Gabrione, research consultant in the U.S. investment manager research group of Mercer Investment Consulting Inc., Chicago.
While most of the biggest hedge fund-of-funds managers are receiving plenty of institutional dollars — among them GAM AG, UBS Global Asset Management, Blackstone Alternative Asset Management, Permal Asset Management and Ivy Asset Management — industry observers said a number of midsize hedge fund-of-funds managers are coming into their own.
Institutional investors are beginning to steer business toward up-and-comers with between $1 billion and $5 billion, such as Attalus Capital Management LLC, CAMG Rock Creek Group, Cadogan Management LLC, Silver Creek LLC, ArchStone Partners LP, Aetos Capital Management and Mariner Investment Group.
Asset Alliance Corp., New York, with about $4.2 billion in hedge fund and fund-of-funds assets, is controlling capacity issues by buying minority stakes in promising hedge fund managers and incubating emerging managers, which guarantees future access, said Bruce Lipnick, president and chief executive officer.
Asset Alliance owns minority stakes in 14 hedge fund managers and in about two weeks will make an investment in a 15th manager, which Mr. Lipnick did not identify.
By buying stakes in two or three hedge fund managers per year and providing start-up capital and investment in another two to three fledgling managers, "we get into the best managers that everyone wants. You have to keep investing to keep capacity open," Mr. Lipnick said. Asset Alliance also uses 24 outside hedge fund managers and offers two funds of funds.
Russell Investment Group, a Tacoma, Wash., manager of managers, offers non-directional, lower beta hedge funds-of-funds strategies which often use capacity constrained underlying managers, said Jeff Geller, director of hedge funds. That necessitates keeping a close eye on the size of assets allocated to each individual manager because "we want every investment we make with every manager to have a meaningful impact on the performance of the portfolio," Mr. Geller said.
Mr. Geller said Russell carefully monitors the cash flow coming from clients and won't accept more on a monthly basis than its portfolio managers are certain can be put to work with underlying hedge fund managers.
"From our standpoint, we want to make sure that we don't continue to grow a particular fund to the point that it is so large that we begin diluting the impact of `high confidence' managers who happen to be closed (and will not accept more cash)," said Mr. Geller, who is based in the firm's New York office.
Russell manages $4 billion in hedge funds of funds.
While hedge fund managers say that institutional investors will have no problem investing all the money they want in the larger hedge funds, institutional investors are having more trouble investing their real estate allocations.
Investing in real estate is getting more difficult as investors are angling for space in the best opportunity funds, consultants and investment managers say.
Real estate funds by managers such as RREEF/Deutsche Bank Real Estate, JPMorgan Fleming Asset Management, Apollo Real Estate Advisors LP and Heitman LLC have been oversubscribed.
Some big investors are continuing to form joint ventures with both investment management firms and real estate operating companies to invest their real estate allocations.
For example, last month the $125 billion California State Teachers' Retirement System, Sacramento, entered into joint venture with First Industrial Realty Trust, New York, investing $300 million in U.S. industrial property. CalSTRS was not the only pension fund competing for the opportunity, said Mike Brennan, First Industrial's president.
First Industrial invests in the development and repositioning of corporate real estate and raises money in part through co-investments, Mr. Brennan said. First Industrial does not raise funds, but co-invests with institutional investors such as Kuwait Finance House, he said.
A number of pension funds vied for the opportunity of entering into the current joint venture with First Industrial, Mr. Brennan said. He declined to identify them or give the number. But he added: "in making the choice we looked at the financial capacity and in the level of sophistication. They (CalSTRS) are sophisticated and knowledgeable and well-advised by CB Richard Ellis."
Investors are clamoring to either co-invest with fund managers or real estate operating companies or invest in real estate funds mainly for the returns but other factors are also enticing, consultants say.
"The performance of the real estate market over the last five years has been spectacular. … Continued appreciation potential, consistent cash flows as well as portfolio diversification are the primary reasons why pension funds are allocating more and more funds to real estate," said Scott Farb, principal with real estate consultant Gumbiner Savett Inc., Los Angeles.
"So far the capital flows into real estate appear to be unabated. So long as commercial property fundamentals improve enough to offset rising interest rates and escalating operating expenses, you will see a lot of interest in real estate, and real estate should continue to perform comparatively well.
"If you see a reversal of the economy or fundamentals get worse such as a rise in the unemployment rate, or lease and occupancy rates go down, returns will decrease. It really depends on the overall economy."
Non-U.S. real estate funds are starting to grow in popularity among institutional investors. A February report by San Francisco-based real estate consultant Kinsley Associates for Institutional Real Estate Inc., a Walnut Creek, Calif., real estate trade publisher. revealed that large tax-exempt plans are more than doubling their allocation to overseas real estate to 8.4% this year from 3% in 2004, Mr. Farb noted.
"According to Ernst & Young (Ernst & Young LLP), opportunity funds are now going abroad with 60% of all the capital going overseas because of the high prices for commercial real estate in the U.S.," Mr. Farb said.
