Foundations, Endowments Remain Bullish on Hedge Funds

Investors favor smaller funds for their ability to generate higher returns

Respondents favored small hedge funds. Respondents favored small hedge funds.

Endowments and foundations continue to favor hedge fund strategies, according to NEPC’s second quarter measure of these organizations’ confidence and sentiment related to the economy, investing and market performance.

Sixty-five percent of respondents reported hedge fund exposure greater than 10% of their total portfolio.

NEPC, an investment consulting firm to endowments and foundations, conducted the online poll of endowments and foundations in July.

Two-thirds of respondents indicated a preference for hedge fund strategies with less than $5 billion in assets under management.

NEPC said in a statement that many investors believed that smaller hedge funds would likely be nimbler and thus drive higher returns.

About a third of respondents said that emerging markets hedge fund strategies would be likeliest to generate the highest returns over the next five to seven years, followed by multistrategy and event-driven strategies.

A recent report said investors had shown increasing interest in event-driven strategies during the second quarter.

Fifty-three percent of endowments and foundations surveyed said they considered hedge funds “a separate investment class” within their investment programs, while 47% said they were “an investment vehicle used to gain exposure within an asset class.”

For 39% of respondents, hedge funds’ primary role in their portfolios was “diversification,” while for 22% it was “volatility mitigation” and for 18% “absolute return.”

Thirty-five percent said they accessed hedge funds directly, another 35% used a combination of direct investment and funds of funds and 29% used only funds of hedge funds.

Survey respondents cited various factors for their hedge fund selections. The top three:

  • Correlation and fit within the portfolio: 69%
  • Compelling investment thesis: 53%
  • Track record: 43%

They also mentioned fee structure, operational proficiency and size of fund as criteria for their selections.

As for reasons they might replace a hedge fund manager, 26% cited “organizational concerns,” 24% “performance concerns” and 21% “moving from funds of funds to direct investments.”

Another segment of the NEPC survey found that the majority of endowments and foundations considered the U.S. economy to be in a better place now that at the same time last year.

NEPC’s first quarter sentiment survey produced a similar finding.

“Respondents continue to display similar levels of economic optimism we’ve seen in our two previous quarterly surveys,” Cathy Konicki, partner and head of NEPC’s endowment and foundation practice group, said in the statement.

Konicki said a slowdown in global growth, rising interest rates and the potential for overseas conflict were the top three areas of concern for endowments and foundations related to their investment performance.

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Check out Hedge Fund Winners and Losers in First Half on ThinkAdvisor.

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