Endowments go hedge

In 2002, 637 US endowments surveyed by Commonfund Institutional Research professed to a greater interest in hedge funds than in private equity, allowing hedge funds to grab a larger share of the endowments' average 33 per cent allocation to alternatives than in 2001. In 2002, 14.4 percent of those surveyed had hedge fund investments, up from the 11.3 per cent that did so in 2001.

Private equity obviously still plays a significant role in endowment allocations, but its slower rate of growth reflects recent disappointment with venture capital investment and a growing reluctance to invest in illiquid assets in tough economic times.

Endowments with a presence in alternative assets tend to invest aggressively. The endowment management for Yale University and the University of Virginia system, among the largest in the United States, have raised their hedge fund allocations dramatically, because they see them as the best sources of returns in otherwise soft and slow markets. Yale, with an endowment of $10.5bn, currently has a hedge fund allocation target of 25 per cent, while aiming to reduce its exposure to private equity.

In the case of the $1.7bn University of Virginia endowment, in fiscal 2002 the manager cut back its US public equity exposure and boosted hedge fund exposure to 50 per cent. Officials say they may even increase hedge fund exposure to 60 per cent in the future.

Pedal to the metal
At the University of North Carolina (UCN) Management Company, which handles $1bn in assets, about $400m is now invested in hedge funds. Mike Hennessy, vice president of the University of North Carolina Investment Company, says the shift to hedge funds, away from both conventional equity investments and private equity funds of all types, is a natural progression for his portfolio. He says the reason some 40 per cent of his assets are now in hedge funds is simple, and informed by painful experience.

?The reason is that we had strong allocations in venture capital in the late '90s,? he says. ?[But] when we sat down and really investigated our venture capital guys, we found that they had by and large changed their model from doing a lot of due diligence, being strict value investors and having a manageable number of investments to a model that was throwing money out the door.?

The university's returns generated from venture capital and private equity returns dropped accordingly. The key to making UNC alternatives allocation work again was to figure out how to anticipate the next opportunity, rather than react to the private equity meltdown, Hennessy says. When the public equity markets closed and the potential for venture capital backed IPOs disappeared, ?that's really when we put the pedal to the metal with hedge funds.?

The latest allocation survey published by US consultancy Greenwich Associates this year confirms that North Carolina is not alone in its partial loss of appetite for private equity. The survey gives an indication of where the money is currently going among US institutional investors.

To be sure, Greenwich found that whereas in 2000, 35 per cent of respondents said they were invested in private equity, this year 39 per cent said they were active in the class, according to senior markets analyst Ryan Randolph.

But while just 12 per cent of respondents in 2000 said they were invested in hedge funds in 2000, 20 per cent of investors surveyed this time said they were in hedge funds.

Private equity, the data says, is neither down nor out, but it isn't shining quite as brightly as far as the institutions are concerned. ?Basically what's happening is that the excitement around private equity is still there, but if you're comparing it just against hedge fund allocations, it can seem like it's lost a bit of its lustre,? Randolph says.

Tellingly though, what the figures also reflect is that private equity's appeal has mainly dulled for institutions that have not yet moved into the asset class. New recruits may be hard to find, but according to Greenwich current investors say they are satisfied and will increase their commitments over the next three years: 26 per cent of active investors predicted that their allocations will see a ?significant increase?, whereas only one per cent of institutions surveyed said they would be scaling back their commitments to the asset class.

General partners will take comfort from the fact that long-standing customers remain in favour of their product.