Endowment funds turn to alternatives

Foundation and endowment funds are allocating the largest percentage of alternatives to their portfolios, with public funds coming second ahead corporate plans in third place.

During the past five years, foundation and endowment funds’ allocations to alternatives rose from 16 per cent in 2005 to 35 per cent in 2010.

According to Callan Associates’ 2010 Alternative Investments Survey, fund sponsors’ allocations to alternatives nearly doubled from 11 per cent in 2005 to 20 per cent in 2010 as they sought greater portfolio diversification and enhanced returns, and that percentage was expected to rise to 24 per cent by 2012.

Jamie Shen (pictured), practice leader, alternative investments consulting for Callan Associates, said the four main deterrents to investing in alternatives were liquidity, cost/pricing and fees, policy and board-level matters and transparency.

Other deterrents included risk (such as asymmetric, headline and political risks), the required use of excess leverage, returns, fund size and regulations.

Funds investing in alternatives generally required some degree of additional support and resources to select, manage and monitor alternative investments, said Shen.

More than 60 per cent of survey respondents used an external consultant or advisor, with public funds ranking the highest at 73 per cent, and about 50 per cent for endowment, foundation and corporate funds.

Smaller plans with less than $1 billion in assets generally did not use an external consultant.

Shen said the progressive shift to alternatives – with inflows coming primarily from domestic equities – could be attributed to equities performance challenges over the past 10 years.

The average domestic equity target allocation had dropped 12 per cent between 2005 and 2010 and was expected to fall another 6 per cent by 2012.

The survey delves deeply into real estate, private equity and hedge fund trends and broadly covers commodities, infrastructure, portable alpha, socially responsible investments, timberland, TIPS, and agriculture.

Real estate was most commonly used alternative by survey respondents (80 per cent), followed by private equity (69 per cent) and hedge funds (52 per cent).

Hedge funds garnered the largest average allocation – about 10 per cent – followed by private equity (8 per cent) and real estate at about 7 per cent.

Callan’s survey also examined secondary market usage of the three main alternative asset classes: real estate, hedge funds and private equity.

Private equity was the most active secondary market, with nearly 40 per cent participating as buyers and 7 per cent as sellers, while real estate and hedge fund secondary markets received little interest from investors.

All reported secondary market purchases occurred after 2003 with 50 per cent taking place in 2009 and 2010.

The survey was done in the third quarter of 2010, and of the 67 organisations surveyed, most – 88 per cent – had current allocations to alternative assets.

Public funds represented 42 per cent of respondents, with corporate funds at 31 per cent and foundation and endowment funds at 24 per cent.

More than 28 per cent of respondents had more than $5 billion in assets under management, 28 per cent had between $1 billion and $5 billion and about 42 per cent had less than $1 billion.