Europe has a keen eye for ‘alternative alternatives’

By Jon Gripshover

"Alternative alternatives" assets are growing faster than other asset classes among European institutional investors, a new report shows.

Among these investments, structured products, options and futures, and exchange-traded funds are attracting the most investors, with 34%, 23% and 26% of institutions, respectively, projected to use them this year, according to the 2005 European Institutional Asset Management Survey, sponsored by INVESCO and Financial Research Corp. At the end of 2004, 56% of the survey respondents reported using one or more of these strategies.

The survey defines "alternative alternatives" as any of the new or complex investment strategies that are difficult to place in traditional categories.

While these strategies are being used is not surprising, the growth rate is higher than expected, said Yves Van Langenhove, head-institutional, Western Europe, for INVESCO Europe, Frankfurt.

"We know that European institutional investors are using more and more the instruments we called ‘alternative alternatives' but we were quite surprised by the future growth of, for example, ETFs," Mr. Langenhove said in an interview. Among survey respondents, 17% reported using ETFs at year-end 2004, while 26% said they will use them going forward, a growth of 50%, he added.

With the increase in the "new" alternatives came a decline overall in the expected use of hedge funds in Europe, the report said. For 2005, 11% of respondents expected to increase their allocations to hedge funds. This compares with 32% in 2004 and 38% in 2003, according to the survey.

The trends are due to a confluence of several factors, Mr. Langenhove said. The higher level of sophistication among investors has a lot to do with it, as does the pressure they feel to boost returns because of low interest rates and the decrease in pension funding ratios. With institutions seeking more alpha, and ways to split alpha and beta, the more complicated strategies are getting more attention.

Structured products are among the hottest investments now because they can provide leverage or downside protection, depending on the need of the investor, according to Mr. Langenhove. Three years of consecutive good equity markets did not erase the investors' memories of bear markets. "You thus see investors buying downside protection through structured products, while others are buying higher expected returns (through other) types of structured products."

Another reason behind the growth of alternatives is investors' search for ways to split alpha and beta. That quest accounts for the growth in the use of options, futures and ETFs, he said. "More and more European investors will use (ETFs) to buy beta."

Most surprising was the expected growth in external management, Mr. Langenhove said. For 2005, 27% of the institutions said they expected to increase the amount of assets allocated to external managers by more than five percentage points. This compares with only 2% of respondents in 2001.

Mr. Langenhove attributed the growth to the corresponding increase in the use of the more complex investment strategies.

The bad news for hedge fund use primarily was based on performance. "The decline was due to the disappointing performance of hedge funds … on one hand and the nice performance of long-only products. … European investors realized that hedge funds aren't the wonder solution for their challenges either," Mr. Langenhove said.

The one bright spot for hedge funds was France, where institutions had an average 2.7% allocation to the asset class at the end of 2004, the largest hedge fund allocation among European investors.

Ninety-eight financial institutions from France, Germany, Italy, Belgium and the Netherlands were surveyed between June and September. The institutions were pension funds, insurance companies, banks, foundations and others, with assets totaling €402 billion ($471 billion).