TACOMA, Wash. — North American institutional investors raised their hedge fund allocations this year, while decreasing private equity and real estate allocations, according to Russell Investment Group's biennial survey on alternative investing.
Median strategic hedge fund allocations in the U.S. and Canada increased to 7.7% in 2005 from 7.1% in 2003, while private equity and real estate allocations dropped to 7% and 6.7%, from 7.5% and 7.1%, respectively. This is the first year hedge fund allocations surpassed the other two alternative asset classes.
Much of the increase in hedge funds was driven by the growth in hedge fund allocations, to 6.1% from 2.5%, by public institutions in North America.
North American institutions expect their hedge fund allocation to get even larger by 2007, growing to 9.1%, compared with 7.6% in private equity and 7.3% in real estate.
In Europe and Australia, the largest alternative investment allocations will be in real estate. European institutions will increase real estate allocations to 10.5% from 9.8%, while Australians will decrease their real estate allocations to 9.9% from 10.4% by 2007.
But hedge funds are gaining elsewhere in the world as well. Allocations to the asset class increased to 5.3% from 3.6% in Europe; to 6.2% from 4.3% in Australia; and to 8.1% from 7.1% in Japan. (The survey report noted small response rates for hedge fund questions from Australian investors and private equity questions from investors in Japan in 2003.)
"Even with a (negative) headline environment with hedge funds, and questions about whether hedge funds could provide returns going forward, it is an area where investors would invest in," said Mark Castelin, director of alternative investments at Russell Investments in an interview. "Returns are at a reasonable level such as it would be included in their portfolios."
"We did ask why those not investing in hedge funds were not, and the predominant reasons were fees did not justify the risk or lack of transparency," Mr. Castelin said.
New questions on the 2005 survey covered other types of alternative strategies such as currency overlay, portable alpha and tactical asset allocation overlay, Mr. Castelin said. Among North American institutions, 30% invest in currency overlay and 26% in timber. Twenty-three percent of survey respondents use portable alpha, with 44% not using but considering using the strategy, and 40% not using or considering the strategy. The least used were commodities and absolute return strategies.
Asked about return expectations through 2007, global investors expect private equity to be the top performing alternative asset class for the next two years. Japanese investors expect private equity to return 15% through 2007; North Americans and Australians, 12%; and European investors peg the return at 10.5%.
In real estate, North American investors forecast an 8.4% return; Australians, 8%; Europeans, 7.5%; and Japanese investors, 5%. Australian investors anticipate a 10.3% return for hedge funds through 2007; North Americans, 8%; European investors, 6.8%; and Japanese investors, 5%.
Except for Japan, where 83% of assets allocated to alternative investments are in hedge funds, the vast majority of the money committed by global institutional investors is in real estate and private equity. In North America and Europe, hedge funds account for only 10% of commitments; in Australia, it's 13%. However, 53% of North American and 30% of European and Australian commitments are in real estate; and 37% of North American, 60% of European and 57% of Australian alternative commitments are in private equity.