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Institutional investors express greater interest in start-ups, according to JP Morgan survey

Date: Thursday, July 14, 2011
Author: Martin Leonard, COO Connect

Institutional investors have expressed greater willingness to allocate capital into smaller and start-up hedge funds, according to a survey by JP Morgan’s Capital Introduction Group (CIG).

Some 69% of the bank’s institutional clients said they would invest in a start-up fund although 59% highlighted they would do so “selectively”. Furthermore, 37% of investors stated they were comfortable investing in a hedge fund with less than $50 million in assets in 2010 compared with 25% in 2009.

“In follow-up conversations with investors, we found that many were interested in smaller funds primarily because the largest managers were beginning to close. Some investors felt they were being crowded out by large institutions, particularly pensions, endowments, foundations and insurance companies that were willing to make substantial placements,” said the report.

Large institutional investors often have concentration limits forcing them to focus their efforts on the biggest managers. The survey revealed unsurprisingly that 43% of investors whose average ticket size exceeded $250 million would not consider managers with less than $1 billion in assets. A survey by Citi Prime Finance earlier this month reached similar conclusions.

The industry is still skewed in favour of the largest, billion-dollar plus managers. The Citi Prime Finance report acknowledged that the 13% of managers who had more than $1 billion in assets managed the vast majority of the $1.7 trillion in total investor capital.

This has encouraged smaller investors to seek alternative sources of alpha. “A secondary but important motivation for many investors was the opportunity to take a large stake in a newer vehicle in its early years, when investing experience suggests it should have its strong returns,” read the JP Morgan report.

Smaller hedge funds tend to outperform their larger, established counterparts because the urgency for generating solid performances and returns is often much greater. The Neuberger Berman 2011 strategy outlook report highlighted emerging managers’ annualised returns stood at 9.49% compared with 7.61% for their bigger peers.

However, manager experience is still a prerequisite for many investors, even if they are allocating to an emerging or start-up fund. “We have found that while many investors are willing to make placements in small or start-up funds, those funds are likely to be managed by experienced managers and not new entrants,” said the JP Morgan report. It added that just under half of the respondents demand a one year track record minimum before considering an investment. Predictably, the majority of pension funds, endowments and foundations required at least two years experience.