October 11, 2005

Despite Promises, European Institutions Never Got Into Hedge Funds

GREENWICH, Conn. (HedgeWorld.com)--European institutional investors never warmed up to hedge funds the way they once seemed poised to do, and now a renewed conservatism in asset allocation may mean a fizzling of the relationship altogether.

Despite telling Greenwich Associates officials for the past three years that they planned to up their allocations to high-alpha strategies that included hedge funds, European institutional investors never put serious money into such strategies. Today the average allocation is around 1%, a level that a new Greenwich research report considers little more than dabbling.

And there are signs in Greenwich Associates' 2005 report on the European investment management industry that preferences are shifting away from hedge funds and higher-yielding strategies, despite eroding funding ratios at pension funds. Greenwich said in the report this movement could be due largely to the demands of new mark-to-market accounting rules that have caused European institutions to halt shifts of assets from government bonds to equities and other higher-yield investments.

The new international accounting conventions, which require assets to be market to market on the books, sometimes causing significant fluctuations in value particularly among less liquid instruments, are gaining acceptance across Europe, according to Greenwich Associates. "The movement appears inexorable," said Chris McNickle, a consultant at Greenwich, in a statement.

The result is that pension funds are increasingly hesitant to shift assets away from easy-to-value, less volatile securities. Problematically, demographic, social and macroeconomic pressures are eating away at funded levels for pension funds, forcing them to seek higher returns. In 2003, the average European pension fund was 105% funded, according to Greenwich research. By 2004, the funded ratio at a typical pension plan had fallen to 95%. In certain countries and regions, it was even lower.

In recognition of this trend, many pension plan executives have been telling Greenwich Associates that they planned to shift assets away from low-yielding bonds and into better performing strategies. It never happened. Government bonds, which accounted for 27% of European institutions' assets at the end of 2002, accounted for 29% of those same institutions' assets as of the end of 2004, according to the Greenwich research. Cash and short-term investments totaled 7% of European institutions' investments at the end of 2002, and 7% at the end of 2004. Allocations to equities have remained flat at 22% since the end of 2003.

Allocations to hedge funds and private equity have remained flat at about 1% for each of the past three years, according to Greenwich. Now that hedge fund returns have leveled off, institutions' interest in the strategy has dropped. The proportion of European institutions saying they planned allocations to hedge funds dropped from 19% in the previous year's report to 8% in the most recent report. The proportion that said they expected to hire a hedge fund manager fell from 23% to 8% during the same period.

Those numbers prompted this quip from Greenwich Associates' Managing Director Berndt Perl: "There are a huge number of hedge fund conferences planned all over Europe for the next year, but who knows who is going to attend them?"

CClair@HedgeWorld.com

Contact Bob Keane with questions or comments at bkeane@investmentadvisor.com.

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