Jun 1

Hedgies’ Assets Grow a Paltry 37%

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Yes, you read that right.  Hedge fund growth slowed to only 37% year over year from a 53% previously.  Total hedge fund assets are now estimated at $2.5 trillion.  http://www.institutionalinvestor.com/Article.aspx?ArticleID=1361809

At this slower rate of growth, hedge funds will control about $10 trillion in assets at the end of the next four year period (2011).

Now, a more realistic assessment.

I do not know if the $2.5 trillion is net of borrowings (which would be significant), but I do know that the financial press loves large numbers (see previous blog post on SWF’s).  More importantly, what does this mean for insurers?

Many large insurers have been HF investors for well over a decade now.  The acceptance of such vehicles as ‘proper’ for insurers has gradually come down the insurer asset size spectrum to where we now see insurers in the 1-5 billion size range seriously considering them.  (Of course, there are a handful of smaller insurers whose Boards have pushed them to dabble.)

Hedge funds are NOT an asset class.  If they are, then Mutual Funds are an asset class, and that would be a grossly incorrect characterization.  HF’s consist of several different strategies.  Thus, they might be considered for an insurer’s portfolio based upon what a given strategy/style can do for the portfolio.

Something that HF’s can probably not do is consistently beat equity market returns.  When lumped together, HF’s have tended to provide BELOW equity market returns.  So, why bother?  They have also tended to provide much lower volatiltiy than equities and lesser correlation with other assets typically held by insurers.  For more on this, we highly recommend AllianceBernstein’s report, “What Lies Beneath?” https://www.alliancebernstein.com/institutional/Registered/ArticleDetail.aspx?cid=32263

Because of this, in analyses we have performed for our clients, it is readily apparent that hedge funds can generally be expected to add a material amount of risk adjusted return to the traditional insurer’s portfolio.

However, before you begin to jump on the HF bandwagon (and risk trying to explain the risks inherent in HF’s to a Board of doubting Thomases), you should remember that using a hedge fund of funds is a great way to pay more fees WITHOUT a concomitant advantage in returns.  The most successful investors in hedge funds (and here we are speaking of certain pension and endowment investors) have focused on choosing individual HF’s after much detailed research about the quantitative and qualitative issues.

An asset class growing at a “paltry” 37% cannot be pushed aside as an alternative for insurer’s non fixed income (or ‘risky bucket’) portfolio.  However, caution, prudence and detailed research is advisable.