Updated with correction Aug. 18, 2010
Institutional investors could face capacity constraints by year's end, thanks to their predilection for investing in big hedge funds.
The hedge fund industry as a whole has plenty of capacity to absorb the amount of institutional investment coming its way, but the major sources of new inflows - institutional investors — are mostly targeting the biggest hedge fund managers, and some of those funds are starting to limit new inflows to protect performance.
The issue could become acute, sources said, because of the sheer volume of institutional money slated to be invested in single-strategy and multistrategy hedge funds over the next 12 months by corporate and public pension funds, sovereign wealth funds and a few endowments and foundations.
Hedge fund consultants predict that the rush of money likely will cause some hedge funds to put on the brakes when it comes to accepting new assets.
The global pot of institutional money destined to be invested directly in single and multistrategy hedge funds, rather than in funds of funds, totals at least $16.8 billion, based on a conservative estimate by Pensions & Investments using reported search activity. The actual total likely will be higher, because many institutions don't disclose their hiring plans.
Among the largest direct investment searches announced this year are the first-time hedge fund allocations of $6.6 billion from the $109.5 billion Florida Retirement System, Tallahassee, and $1.4 billion from the $80 billion State of Wisconsin Investment Board, Madison.
Funds that are switching to direct investments from funds of funds include the €87 billion ($114 billion) Dutch pension fund Zorg en Welzijn, for its $1.6 billion hedge fund portfolio, and the $25 billion South Carolina Retirement System, Columbia, for its $5 billion portfolio.
“We have a situation where hedge fund (industry) assets are near their all-time peak and many of the largest hedge funds have more demand than they can handle, while a vast majority of hedge funds have seen very little inflows and are significantly below their peak assets,” Donald A. Steinbrugge, managing partner of hedge fund consultant and third-party marketer Agecroft Partners LLC, Richmond, Va., wrote in an e-mail response to questions.
Much of the new capital the big hedge fund shops attracted in the 12 months ended June 30 came from institutional chief investment officers who still are playing it safe after the financial crisis by concentrating their direct investments in large, name-brand hedge fund managers, said Howard B. Eisen, managing director of hedge fund consultant and third-party marketing firm FletcherBennett Capital LLC, New York.
“After the Madoff fraud in 2008 and liquidity problems in 2008 and 2009, you can understand why institutional investors wouldn't want to take the risk of investing with a smaller manager that lacks a brand name and strong infrastructure,” said Vidak Radonjic, managing partner of alternatives consultant The Beryl Consulting Group LLC, Jersey City, N.J.
Added Mr. Eisen: “Nobody is getting paid to take career risk. If your hedge fund investments wildly outperform, no one is going to say anything. But if your hedge fund investments wildly underperform or there's a blowup, you may lose your job.”