LONDON (HedgeWorld.com)–Pension fund trustees wanting to invest in a fund of funds may want to consider the full effect of their asset allocation decision.
According to a paper published by Watson Wyatt LLP Investment Consulting on the topic of capacity, pension funds and other institutional investors may find themselves competing with funds of funds to place money with the best and brightest.
Calculating that roughly one-third of capacity available from highly talented hedge fund managers is taken up by funds of funds, the amount of capacity available to other investors annually dwindles by US$33 billion on an annual basis.
“The concern for pension funds is how to successfully access this pool of talent,” wrote Watson Wyatt officials in the report.
An estimate of an additional US$50 billion in capacity available to all each year is based on the assumption that new fund launches will continue at the rate of 500 to 1,000 per year and that about 5% of the managers are highly skilled and could manage US$1 billion in assets.
Watson Wyatt warned investors about some potential problems inherent to growing fund of funds inflows. The concern is heightened by the preference institutional investors have for these managers.
In a poll of 18 funds of funds managers, the surveyors found that the funds’ assets grew by 33% over the first six months of 2004. Researchers said that growth beyond US$2 billion per year for each of the best funds of funds would be difficult to sustain.
Specifically, the problem of continuous inflow momentum over the last year has pushed down the performance spread between the best and the worst managers, resulting in lower overall returns for absolute return managers. Even though the stock market may have been to blame, Watson Wyatt consultants still expressed worry over future return prospects
The firm estimates that pension funds need to achieve a 2.5% to 3% return above that of cash in order to improve the efficiency of a portfolio with a 5% allocation to hedge funds.