Substantial increased allocation to hedge funds expected

Investors are planning significant allocations to hedge funds this year. The increased inflow is associated with more rigorous due diligence and risk management.

Almost three quarters (73%) of investors are predicting inflows of at least $100 billion in 2010, according to Deutsche Bank's annual alternative investment survey. The report estimated inflows could be closer to $222 billion.

Using Hedge Fund Research 2009 year-end figures, Deutsche Bank said this inflow could bring total industry assets to $1.7 trillion. Other sources have estimated the industry is already at $1.8 trillion so the report's forecast could push the industy to $2 trillion by year end.

The survey found 29% of investors were looking to reduce cash levels with at least 10% of cash to allocate. Almost three-quarters (72%) of investment consultants said clients were increasing allocations to alternatives.

Investors were keenest to allocate to funds investing in Asia (excluding Japan) and emerging markets. Equity long/short, closely followed by distressed, global macro and event-driven, were the strategies where investors were most likely to increase their allocations.

Start-up funds look likely to struggle as 42% of investors said they were invested with managers running over $1 billion of assets. Half of the survey respondents said funds had to have at least $100 million in assets under management (AUM) before they would invest.

The number of managers with whom investors have money has been decreasing since 2008. Deutsche Bank said this was partly due to the increased level of due diligence now required, as fewer managers meant investors were able to monitor their investment more closely.

A good majority (80%) of investors would not make a new allocation to a manager who had frozen or suspended assets or increased side pockets. Investors said asset freezing was the most damaging action to a fund's reputation.

Investment performance is becoming less important when choosing a hedge fund manager, although over 70% of respondents still select it as one of the most important selection factors.

Risk management and investment philosophy were the next most important factors for selecting a manager.

Investors believed regulation would be the greatest challenge for managers this year. That was also reflected in the 50% year-on-year increase in the number of investors expressing an interest in Ucits funds.

Over a third (34%) of respondents said they would have Ucits investments in the next 12 months and a similar proportion (33%) said they would rather invest in a Ucits III-compliant hedge fund than its Cayman-domiciled counterpart.

Similarly 14% of investors already use managed accounts, with a further 26% likely to use managed accounts in the near future.

Deutsche Bank surveyed 606 investors with a total of $1.07 trillion in hedge fund assets. The largest proportion (42%) were funds of funds, with asset management companies and family offices accounting for a further 21% and 12% respectively.

Almost half the respondents were based in North America. A further 36% were from Europe and 11% from Asia.