If 2009 was the worst of times for institutional investment in hedge funds and funds of funds, 2010 is shaping up to be among the best.
Net inflows from institutional investors worldwide into hedge funds totaled just $21.5 billion for the year ended Dec. 31, down 40% from 2008 and 68% from 2007. In fact, last year's net inflows were 10% below the previous low of $23.8 billion in 2004, the first year Pensions & Investments tracked institutional investment in hedge funds.
The good news for hedge fund and funds-of-funds managers is that industry observers expect the pace of hedge fund investment — and total new dollars invested — to be extremely strong in 2010. And early numbers appear to bear this out.
Driven by a number of large, first-time hedge fund investments and significant increases in hedge fund allocations by other institutions, net searches and hire this year already totaled $12.3 billion as of March 19.
If that rate continues for the rest of the year — as consultants predict it will — 2010 could end with more than $49 billion of net new hedge fund inflows from institutional investors, the second-best year since P&I began tracking the data. Sources don't think it would be possible to top the record $66.1 billion net inflows institutional investors directed, by P&I's calculations, into hedge funds in 2007.
(P&I's estimate of net hedge fund activity likely is low, based on reported hedge fund allocation increases, searches, hires, postponements and terminations. Amounts are not routinely given when searches are made public, and many searches and hires are never announced publicly.)
Among large institutions planning big first-time hedge fund investments are the $137.9 billion Florida State Board of Administration, Tallahassee, and the $77.5 billion State of Wisconsin Investment Board, Madison.
Veteran hedge fund investors, like the $67 billion New Jersey Division of Investment, Trenton,and the $43.6 billion defined benefit plan of Boeing Co., Chicago, are significantly increasing their hedge fund allocations. Boeing is converting the majority of its hedge fund portfolio to invest directly in single-strategy and multistrategy hedge funds, rather than through hedge funds of funds. Other large pension funds, including the $25 billion South Carolina Retirement System, Columbia, also are converting.
The surge in hedge fund investment comes after a torturous period for many institutional investors already in or contemplating investment in hedge funds, said alternative investment consultant Stephen L. Nesbitt, CEO of Cliffwater LLC, Marina del Rey, Calif.
“A lot of investors got really spooked about all of their investments, but particularly hedge funds, after (quantitatively managed) strategies got hammered in the third and fourth quarter of 2007,” Mr. Nesbitt said.
Then the credit crisis in 2008-'09 froze many investors' hedge fund activity. Mr. Nesbitt and other sources said investors halted hedge fund investment plans in the late 2008 and were very slow to reinstate them in 2009.
That hesitation was evident in the first three quarters of 2009.
Net hedge fund inflows from institutions were down 56% in both the first and second quarters of 2009 ($3.8 billion and $4.5 billion, respectively, compared with the year-earlier periods.)
The third-quarter net inflow of just $780 million was the worst quarterly figure in P&I's six years of hedge fund investment tracking and represented a decline of 92% from the third quarter of 2008.
The fourth quarter, however, showed a remarkable turnaround, with net inflows of $12.4 billion, up almost 1,500% from the third quarter inflows and up 92% compared with the fourth quarter of 2008.
“These numbers reflect the industry trend perfectly,” Mr. Nesbitt said. “Institutional investors remained frozen from the end of 2008 through the first three quarters of last year. There was very little hedge fund activity.
“But investment began to ramp up again in the fourth quarter. And the partial 2010 first-quarter data show that the investment trend remains strong. I think there is going to be an absolute tsunami of institutional money going into hedge funds. Many investors and their consultants and advisers now consider hedge funds the preferred alpha delivery system,” Mr. Nesbitt said.