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Hedge Fund Investors Optimistic, Will Pay for Quality: Deutsche Bank

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Hedge fund investors are feeling optimistic about 2016, expecting hedge funds to outperform equity markets, Deutsche Bank reported Tuesday in announcing highlights of its latest alternative investment survey.

In January, hedge funds staggered to their worst loss in nearly four years, but it is still early days.

Forty-one percent of respondents said they planned to increase their hedge fund allocations during the year, and assets were expected to grow by approximately 5%, passing the $3 trillion mark, the report said.

DB surveyed 504 global hedge fund investors, representing $2.1 trillion in hedge fund assets, on their current sentiment and allocation plans for 2016.

Even though management and performance fees have edged downward, investors will pay for quality, according to the survey.

The average management fee remained unchanged year on year at 1.6%, while the average performance fee has fallen from 18.03% to 17.85%.

However, 42% of respondents said they would allocate to a manager with fees in excess of the traditional “2 and 20” for a new allocation.

The study found pension funds’ allocations to hedge funds trending upward. The average pension fund had an 8% allocation to hedge funds, up from 7% in 2015.

In addition, 71% of pension fund respondents said they had used an investment consultant, compared with just 15% in 2010.

The bank noted that this trend was contributing to a change in pension funds’ portfolio allocation tactics, including a more scientific focus on alpha versus beta and greater demands around operational excellence.

Some two-thirds of respondents said their top quartile of hedge funds had returned, on average, 10% or more in 2015, while nearly half reported that their bottom quartile of hedge funds had lost 5% or more on average for the year.

Preqin, the alternatives data provider, reported that its all-strategies hedge fund benchmark recorded gains of 2% last year, compared with 4.7% in 2014.

According to the DB report, selecting the right hedge funds — those with a unique skill set, competitive advantage and true alpha proposition — was increasingly critical for investors.

“Investors are becoming increasingly sophisticated in constructing their hedge fund portfolios,” Anita Nemes, the firm’s global head of capital introduction, said in a statement.

“The return dispersion seen in 2015 means that choosing the right manager and constructing the right portfolio is ever more. Investors are concentrating and redesigning their portfolios in search of less correlated, diversified return streams.”

Allocation Trends

More than two-thirds of respondents reported that they invested in systematic strategies, including one in every two who planned to add to one or more quantitative substrategies in 2016.

DB found that the largest investment consultants and pension funds were driving this demand: 45% of these respondents expected to add to one or more systematic strategies, including quantitative equity market neutral, commodity trading advisors, quantitative macro, quantitative equity and quantitative multi-strategy.

Managers that have been able to deliver alpha on both the long and short side of the book regardless of market directionality are well placed to benefit from this year’s investment flows, according to the report.

It said equity market neutral strategies were expected to be among the best performers in 2016 following strong performance last year. Hedge Fund Research reported in early February that these strategies were up 4.9% for the 12 months to January.

They are also the most in demand, according to DB. On a net basis, 32% of investors said they were increasing their exposure to fundamental equity market neutral, up from 17% last year, and 18% to systematic equity market neutral, versus 11% last year.

Twenty percent of respondents reported that they invested in alternative beta/risk premia strategies today, up from 15% last year and 8% in 2014. Sixty percent of these planned to raise their allocation in 2016.

DB said some investors were adding more liquid and cheaper alternative beta/risk premia strategies to their core “alpha” portfolios in order to allocate risk capital more dynamically and efficiently.

The report found that multi-strategy and event-driven strategies would likely experience the highest turnover this year, with 16% and 20% of respondents, respectively, planning to redeem, and 9% and 18% planning to increase their allocations.

What Investors Look For

More than two-thirds of respondents cited “access to founders/CIOs/senior investment professionals” as one of the top three factors influencing manager selection.

Moreover, “we are seeing greater demand for tailored strategies and products that cater to investors’ changing needs and requirements,” Greg Bunn, DB’s global co-head of prime finance at Deutsche Bank, said in the statement.

Investors are demanding more nontraditional hedge fund products, with a growing number of investors allocating to alternative UCITS strategies, alternative ’40 Act mutual funds, hybrid private equity/hedge fund vehicles, hedge funds run long only and co-investment opportunities.

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