Greenwich Associates Predicts Flight to Alt. Investments

March 11, 2005 ( - Faced with "persistently low" funding and solvency ratios, US institutional investors are chasing the promise of souped up returns in other places such as international equities and alternative investments like hedge funds, according to new research.

A Greenwich Associates news release said its latest research revealed that more than a third of US institutional investors expect to make a significantly increased commitment to hedge funds in the next three years, while another 30% plan sizable additions to private equity and almost a quarter plan similar increases to their equity real estate.

The company said that the assets funding these increases will come largely from core asset classes. Between 12% and 13% of US funds expect to make a significant decrease to domestic equities in the next three years, and another 12% plan to cut allocations to passive international stocks. In addition, one in 10 US funds plan to make meaningful cuts to their fixed-income allocations in the same period, according to the news release.

In terms of asset allocation, US public and private pension plan sponsors, endowments and foundations reduced their average fixed-income holdings from 26.8% of total portfolio assets in 2003 to 23.7% in 2004. During that period, US funds kept allocations to domestic stocks roughly stable at approximately 47% of plan assets – a level that is much reduced from the more than 52% reported in 2000 and could fall further, Greenwich said.

In equity real estate, allocations increased from 3.6% to 3.8% of total plan assets in 2004. At the same time, institutional allocations to private equity increased from 3% to 3.4% of total assets from 2003 to 2004, and the research suggests that additional growth could be ahead. Among US institutional investors, international equity holdings grew from slightly more than 11% of total fund assets in 2003 to more than 13% in 2004. At the same time, hedge fund allocations grew to 1.6% of plan assets over the past 12 months.

Money managers may plan additional commitments in the alternative investment space, but they are apparently cautious about the returns they expect, according to the research. Endowments dropped their five-year annual return expectations for hedge funds from 9.2% in 2003 to just 8.4% in 2004, while public funds lowered their hedge fund expectations from 9.2% to 8.5% and corporate hedge fund expectations decreased   from 9.1% to 9%. Average return expectations also fell for equity real estate and private equity, with expected returns on equity real estate declining from 8.2% in 2003 to 8.1% in 2004, and the average expected rates of return on private equity fell from 11.3% to 11.1%

Also, US funds decreased their expected rates of returns on all major asset classes from 2003 to 2004. The average annual rate of return expected by US institutional investors from fixed income over the next five years fell sharply from 5.9% in 2002 to 4.9% in 2004. At the same time, the average domestic equity return expectations among US funds dropped from 8.2% to 8.1% over the same period.

But, despite the caution about expected returns, Greenwich Associates said that hedge fund investments will still remain on their current trajectory of cautious growth, due to the return advantage that the asset class offers over other investment options and the additional benefits promised by hedge funds.

These observations are based on Greenwich Associates’ 2005 US Asset Allocation research, for which Greenwich conducted in-person interviews with fund professionals at 610 corporate funds, 242 public funds, and 235 endowments and foundations.