Institutions participating in the survey currently have, on average, 22% of total fund assets in alternative investments. Diversification was cited as one of the top three reasons for using alternatives by 90% of respondents, while volatility management and low correlation to traditional investments was mentioned by 64%, and return potential was noted by 45%.
Additionally, the majority of respondents indicated that allocations would remain static or increase over the next one to three years across all alternatives categories. Thirty-two percent of respondents expect to increase their investment in hedge funds and private real estate, 28% in private infrastructure, 25% in private equity (PE), 20% in commodities, and 12% in public real estate and public infrastructure.
At least 30% of respondents indicated they were below their target weights in hedge funds, private real estate and private equity, while traditional investments – cash, fixed income and equities – were more frequently over their target allocation than under their target allocation. Cash, specifically, is over-target for 45% of respondents, which may indicate that they are being cautious about taking risk and waiting for the right time to reposition cash.
Forty-nine percent of respondents who participate in hedge funds currently utilize the fund of funds structure approach. This is more than double the percentage of that for any other hedge fund implementation method, however, this year’s survey shows respondents anticipate making shifts away from the traditional fund of funds model. Only 17% of respondents using hedge funds expect to utilize this traditional structure for implementation over the next one to three years.
While fund of funds vehicles are anticipated to lose ground, all other implementation methods are expected to gain. Additionally, 63% of survey respondents are obtaining customized hedge fund solutions to complement existing exposures, pursue niche opportunities and access strategy-specific expertise.
Consistent with previous surveys, private equity is more prevalent in North American portfolios, although Europe is not far behind. In both North America and Europe, more investors are currently committed to small/medium buyout funds than to larger funds. Significantly, both North American and European investors expect small to modest decreases in their current PE commitments over the next one to three years. Co-investments and alternative energy are expected to show the largest increases in commitments over the same time period.
Listed real estate investment trusts (REITs) and unlisted private real estate funds continue to dominate as implementation choices, with 51% of the respondents (who hold real estate currently) using them. Only 38% of these respondents, however, said real estate funds will continue to be an implementation choice in the next one to three years. Allocations to direct property investments (23%) and customized separate accounts (15%) are expected to rise in the near future.
Even with inflation-sensitive characteristics, commodities remain a niche solution and future possibility (more than a current reality) for most institutional investors. Among the small sample of survey respondents who hold commodities (32 in number), long futures exposure is the most popular type of investment (63%), with private equity (44%) and hedge funds (28%) trailing. Long/short strategies and funds have not yet made much of an impact (23%), but interest in them is rising, with 46% of current commodity investors expecting to add long/short over one to three years.
Although public and private infrastructure investments command only a small share of institutional assets (just 1% of the combined asset allocations of all respondents), many signs point to growth. Private infrastructure investments appear to be attracting a growing portion of institutions’ illiquidity budgets, perhaps taking assets away from private equity.
Boards and trustees are demanding more education about alternatives and are becoming more receptive to proposals that have included education. Given the dynamic nature of the alternative investment marketplace, 36% of respondents indicated that additional education about alternatives is needed within their organizations.
Russell has observed a growing respect among North American (NA) investors for comprehensive due diligence since its 2010 Survey. In the 2012 Survey, 91% of NA investors said they require comprehensive operational due diligence before making new investments (vs. 68% globally). Responses to this line of questioning signal a trend in institutional investors’ approach to working with external resources. Even some sophisticated investors have decided that they could better achieve their investment objectives by combining the expertise of internal and external resources to manage multi-strategy alternatives.
Between January and March, 146 institutional investors in North America, Europe, Australia and Japan representing a total of $1.1 trillion in assets completed the online survey.
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