Hedge fund managers need to enhance their risk management infrastructure and risk reporting and institutionalize transparency policies to attract new capital, satisfy anxious investors and protect their reputations, according to an annual global study published Tuesday by SEI Knowledge Partnership in collaboration with Greenwich Associates.

The studyalso revealed the importance of fund managers clearly articulating how their investment strategies add value to investors' portfolios, which presents an opportunity to differentiate themselves through market-leading client service, reporting and education.

The study results found that institutional investors' confidence in hedge funds is growing, as 54% of survey respondents said they plan to increase target allocations over the next 12 months. However, that confidence was contingent on greater transparency and increased risk management.

In fact, the focus on risk management infrastructure emerged as the second most important hedge fund selection criterion this year, with 75% of respondents deeming it "very important."  (Notably, it was not among the top 10 selection factors in SEI's report last year.) Only clarity of investment philosophy ranked higher than risk management, with 79% deeming it "very important"—emphasizing the growing demand among investors for transparency and understandable investment strategies.

"The study confirms what we have been seeing and hearing from our clients—that investors are committed to hedge funds, but managers must get and keep investors comfortable with their investment decision," Phil Masterson, managing director for SEI's investment manager services division, said in a statement. "Managers must differentiate themselves through increased transparency, enhanced risk management and reporting as well as better overall client service to gain and retain assets post-financial crisis and post-Madoff."

Transparency is still a concern, as 70% of those polled pointed to a lack of transparency as their biggest worry, up from 56% in 2009. As for the types of information sought, more than three out of four respondents want risk analytics from managers—a category of information that did not appear in the top 10 last year.  

Liquidity remains top-of-mindas well, as more than half of investors named liquidity risk their biggest worry in hedge fund investing, with some 40% saying they have taken steps to enhance the liquidity of their hedge fund investments.

The report also noted that investors are not relying on regulation to improve hedge fund disclosure, liquidity or risk management. Nearly one-third of respondents cited "limited regulation" as a primary concern of hedge fund investing.

SEI's Investment Manager Services division provides comprehensive operational outsourcing solutions to global investment managers focused on mutual funds, hedge and private equity funds, exchange traded funds, collective trusts and separately managed, as well as institutional and private client, accounts.

Greenwich Associates, based in Stamford, Conn., provides research-based strategy management services for financial professionals.