An appreciation of how hedge fund strategies can work within core portfolios could mean up to $3 trillion flowing into the sector over the next five years.
(June 18, 2012) -- Hedge funds could receive a $1 trillion boost from institutional investors over the next five years as pension funds and managers of other large asset pools are regarding sector as core and complementary to their mainstream portfolios, Citi has claimed.
Institutional investors could pile in enough new assets by 2016 to raise the current record $2.13 trillion managed by the hedge fund industry by around 50%, a report published by Citi's Prime Finance Business Advisory Services has predicted.
"In the years since the global financial crisis, a new approach to configuring institutional portfolios is emerging that categorizes assets based on their underlying risk exposures," a report from the investment bank this month said. "In this risk-aligned approach, hedge funds are positioned in various parts of the portfolio based on their relative degrees of directionality and liquidity, thus becoming a core as opposed to a satellite holding in the portfolio."
This shift could mean inflows growing substantially. At the end of March, hedge fund assets had reached record levels through inflows and good performance, according to Hedge Fund Review.
Citi said this increase could gather pace as investors considered some hedge fund strategies ideal candidates to sit alongside their mainstream investments. Investors are set to use these strategies to protect their portfolios from downside risk as well as aim for outperformance, Citi said.
"Directional hedge funds (50%-60% net long or short and above), including the majority of long/short strategies, are being included alongside other products that share a similar exposure to equity risk to help dampen the volatility of these holdings and protect the portfolio against downside risk. Other products in this category include traditional equity and credit allocations, as well as corporate private equity."
Other strategies, such as Macro hedge funds and volatility/tail risk strategies are being included in a stable value/inflation risk category with other rate-related and commodity investments to help create resiliency against broad economic impacts that affect interest and borrowing rates, Citi said.
Absolute return strategies continue to be popular with investors seeking pure outperformance, the bank added.
Long-only asset managers will increase their push to take a piece of this action, Citi said. However, they may find the competition tougher to beat than had been the case previously as investors may tend to favour specialists.
Citi estimated that there could be up to a further $2 trillion to be split between long-only and hedge fund managers in this fight for investors opting for strategies run by both sides.