Why High Net Worth Individuals Are Running Away From Hedge Funds

Flee Running

Hedge funds have surpassed the magic $2 trillion mark.

And new hedge fund launches have reached their highest levels since 2007, with nearly 300 hedge funds launched in the first quarter of this year, according to HFR.

However, one group seems reluctant to participate in this renewed euphoria: high net worth individuals.

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According to the recently released Capgemini and Merrill Lynch Global Wealth Management 2011 World Wealth Report, just 5 per cent of the HNWI set’s assets were found in alternatives investments—hedge funds, structured products, derivatives, foreign currency, commodities, private equity, and venture capital at the end of 2010.

This was exactly half the 10 per cent allocation made in 2006. (HNWIs are defined as those having investable assets of US$1 million or more, excluding primary residence, collectibles, consumables, and consumer durables.)

What’s more, the exposure has steadily declined since the peak.

And within the alternatives group, hedge funds are not exactly the favoured asset class.

According to the survey, commodity investments accounted for 22 per cent of all alternative investments made by HNWI in 2010, up from just 16 per cent the prior year. Foreign currency holdings climbed to 15 per cent of all alternative investments in 2010 from 13 per cent.

“Investors bought into currencies where country interest rates were higher than in the developed markets of the U.S. and Europe,” the report notes.

On the other hand, hedge-fund holdings declined to 24 per cent from 27 per cent in 2009. The report points to a Hedge Fund Research report that stressed most of the hedge fund inflows in 2010 took place at the end of the year.

Investors are apparently still spooked from the days of the financial meltdown, when many of their funds of funds investments performed poorly. And many hedge funds gated their assets, preventing them from redeeming.

“High net worth individuals are looking for liquidity,” confirms William Sullivan, Global Head of Market Intelligence, Capgemini Financial Services. “Their top priority is preserving capital.”

This sentiment is also underscored by the increased allocation to cash and fixed income investments in recent years. The report found that HNW individuals held $18.6 trillion or 43.5 per cent of all their assets in conservative instruments such as fixed-income and cash/equivalents, up from 35 per cent in 2006, even though global equity-market capitalisation had risen 18 per cent in 2010 and 46.3 per cent in 2009.

This reflects an underlying uncertainty that markets will remain stable and that the financial crisis is over and fear that new and unforeseen systemic shocks could emerge, the Cap Gemini/ML report emphasises. “HNW investors are not easily convinced that alternative or emerging opportunities are worth the risk,” the report adds.

The declining commitment to alternatives among HNWI contrasts with that of institutional investors. According to a recent Preqin survey, 30 per cent of institutional investors said they will definitely invest more capital in hedge funds over the next three years and 64 per cent are considering doing so.

And in March, Preqin reported a 50 per cent rise in public pension plans investing in hedge funds.

And earlier this year, hedge fund consultant Cliffwater noted that endowment allocations to alternatives exceed 50 per cent of assets, up from 37 per cent before the financial crisis. It added that hedge funds now account for 3 per cent of total public pension assets and 18 per cent of alternative assets, up from 2 per cent and 15 per cent, respectively, in fiscal 2009.

It looks like those who act as fiduciaries for their own money are much more conservative than fiduciaries for other people’s money.

This post originally appeared at Institutional Investor.

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