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Investment Risk Biggest Worry, HF Investors Say

The latest Credit Suisse Annual Hedge Fund Investor Survey has revealed that a focus on risk management issues is continuing to grow, with investors increasingly concerned about high standards of due diligence.

(March 4, 2011) -- Credit Suisse's annual hedge fund investor survey, which collects responses from institutional investors representing $1.2 trillion of hedge fund investments, has shown that hedge fund investors are most concerned about investment risk.

Next in priority risk to hedge fund performance were changes in EU regulations; asset/liability mismatches in hedge funds; changes in US regulations; counterparty/credit risk and asset/liability mismatches in fund-of-funds, exemplified by funds continually seeking to find a balance between using fund-of-funds and investing directly in hedge funds.

Furthermore, the survey found that many of the responses about investment preference were similar to last year, which marked a shift in investor demands. Edgar Senior, global co-head of capital services at Credit Suisse in London, told Financial News: "Last year it was clear that investors had become significantly more demanding and discriminating than they had in the past. A lot of that has now been institutionalized in the market. The strong conclusion is that we've reached a period of stability and emerging consensus."

The study, which surveyed 600 investor groups, including pension funds, consultants, family offices and funds of hedge funds that represent a total of $1.2 trillion in hedge fund allocations, found that on average, respondents anticipate industry growth of 18% this year to $2.31 trillion from the current $1.96 trillion. The recent research by Credit Suisse supports earlier evidence from Preqin's study of 60 hedge fund managers from Asia, US, Europe, and other parts of the globe that found that institutional investors have revolutionized the hedge fund industry.

"The consensus is clear: hedge fund managers are witnessing large inflows of capital from institutional investors, and are adapting their fund strategies and marketing accordingly," said Amy Bensted, Preqin's manager of hedge fund data, in a statement. "Smaller funds continue to find it more difficult to attract institutional investors, as many do not have sufficient assets under management to be a viable investment option for some of these investors. However, most fund managers are expecting more money from institutional coffers over 2011 and into 2012, suggesting that the proportion of institutional capital in the sector is due to grow even more over the next 18 months."

One fund making changes to allocation as a result of reevaluating investment risk has been the $48.7 billion Massachusetts Pension Reserves Investment Management (MassPRIM), which decided to shift from a fully fund-of-funds investment strategy to incorporating more direct hedge funds, reflecting the need to adapt as circumstances change.

"Tim Cahill, our previous treasurer, felt that having a fund-of-funds approach would achieve better diversification," MassPRIM spokesman Barry Nolan confirmed with aiCIO. "But there's also the argument that with a fund-of-funds strategy, you can reach a point of diversifying too broadly, leading to diminishing returns," he said, noting the while Cahill, who suffered a tarnished reputation over accusations of political influence, achieved solid returns as treasurer, concern centered on the middle layer of management that his fund-to-funds approach created.

As of earlier this month, among the nation's 10 public funds with the largest allocations to hedge funds, MassPRIM and the Pennsylvania State Employees' Retirement System were the only two funds to remain solely invested in funds-of-funds, according to materials provided by MassPRIM's board. On the flip side, according to those materials, the hedge fund allocations of five of the top 10 -- Pennsylvania Public School Employees' Retirement System, Virginia Retirement System, the Teacher Retirement System of Texas, the New York State Common Retirement Fund and the Texas County & District Retirement System -- are entirely invested directly in hedge funds. Others have a mixed approach. The removal of fund-to-funds brings MassPRIM more in line with the strategy of the majority of its peers. "We're not going to do things just because other funds are doing it, but we're doing it on the belief that performance will be enhanced. We're putting our toe in the water. We're not doing a cannonball off a cliff," Nolan said.