CHICAGO (HedgeWorld.com)–Large institutional investors worldwide in greater numbers are considering hedge funds and are increasing their stakes in the emerging asset class, according to a newly released survey on alternative investments from Goldman Sachs and Russell Investment Group.

The survey, which was last conducted in 2001, shows how the acceptance of alternative investments and hedge funds in particular has matured in just a couple of years. Among the 325 institutions with at least US$3 billion in assets interviewed, the commitment to hedge funds grew substantially in North America, Europe, Japan and Australia.

According to officials, clients are looking for alpha-generating strategies and are diversifying into hedge fund, particularly in regions such as the United States where hedge funds provide more diversification from equities than private equity strategies do.

Nowhere has the switch been so significant than among pension funds. In North America, the median strategic allocation to hedge funds for corporate pension plans is now at 3% and projected to grow to 5% by 2005. For public pension plans the median strategic hedge fund allocation in 2005 is expected to be 2.9%, which is up from the 1% allocation registered in 2001.

If a pension fund has even a 1% outperformance, it can reduce the pension plan’s contribution rate by 15%, said Nigel O’Sullivan, managing director in Goldman Sachs International’s pension and insurance strategy group, London.

“Hedge funds are relatively small in terms of allocations but growing dramatically,” said Hal Strong, president and managing director of alternative investments at Tacoma, Wash.-based Russell Investment Group, co-leader along with Mr. O’Sullivan of the survey team.

The number of respondents that invest in hedge funds grew by 40% worldwide, according to the report. The most popular strategies are long/short equity and convertible arbitrage. Annualized returns for hedge funds are forecasted to range between 9% and 7% in 2005.

The report split its results by region, highlighting North America, Europe, Japan and Australia.

In North America, hedge fund commitments grew by 42% from 2001 to 2003, from US$12 billion to US$17 billion. A total of 23% of the investors said they invested in hedge funds this year, with another 8% saying they would begin investing in hedge funds within two years. The median allocation to hedge funds is highest among endowments and foundations at 10%, while corporate pension funds allocate 3% and public pension plans 1.9%.

In Europe, the story is similar with investments in hedge funds shifting from externally managed funds to funds of funds. A total of 21% said they invested in hedge funds, while another 29% indicate they will be investing in the asset class in the next three years. Among those institutions invested in hedge funds, the number allocating to funds of funds increased from 62% to 86%. The most popular strategies are long/short equity and market neutral.

Equity market neutral strategies are also popular in Japan, where 41% of the institutions interviewed have invested in hedge funds, a 50% increase from the number of investors allocated to hedge funds there in 2001. The average strategic allocation to hedge funds was set at 4.5% in 2001, while this year it is 7.1%. Goldman and Russell estimates that the strategic allocation will grow to 8.5% by 2005.

Significant growth also is predicted in Australia, where the average allocation is now set at 11.2%. A total of 80% of Australian institutional hedge fund investors predict that their allocation will rise in the next three years, while no one expects their hedge fund allocations to decrease. Those not yet invested in hedge funds, like their counterparts around the globe, cite risk as a reason not to invest. They also point to a lack of returns and lack of interest among the institution’s investment committee.

Overall, investors not interested in hedge fund investing most often are concerned with transparency and risk, according to the report. Some cite a shortage of internal resources.

Regardless, hedge funds continue to move steadily into a key position within institutional investors’ alternative investment portfolios, as the percentage of capital committed to hedge funds is on the upswing, the survey concluded.

SBarreto@HedgeWorld.com