New research by Towers Watson shows that institutional investors continue to diversify their investment portfolios into alternative assets through direct funds rather than funds of funds. The data show that in 2012 its clients, that included pension funds, sovereign wealth funds and insurance companies, allocated 70 percent more assets to hedge fund and private market strategies than in 2010, reaching $12 billion.
"Throughout the past five years, the alternative fund managers we've placed in client portfolios have shown their ability to adapt to the changing environment to generate good net-of-fees performances. Larger institutional funds are likely to continue to invest in funds directly for most alternative asset classes, rather than via funds of funds, as investors continue to focus on better fee structures and greater transparency," said Zainul Ali, head of manager research, Americas, at Towers Watson.
In 2012, the number of hedge fund mandates awarded to direct funds continued to increase, especially in the macroeconomic, fixed income and reinsurance areas. Similarly, in private markets, real estate, private equity and infrastructure, direct funds received the vast majority of assets. During the year, there was particular interest in infrastructure globally, with three times more assets being awarded to investment managers by Towers Watson's clients than in 2011.
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The data also show that Smart Beta strategies, which capture a premium over time or improve portfolio efficiency through diversification, continued to attract a significant amount of assets ($5 billion) in 2012. These new Smart Beta mandates were mainly allocated in the bonds, commodities and equities, and to a lesser extent in reinsurance, hedge fund and infrastructure. Towers Watson's institutional investment clients have now allocated more than $20 billion to Smart Beta strategies to date.
"These Smart Beta strategies range from relatively simple ideas — such as real estate securities and specialist infrastructure strategies to create liquid diversity — to doing existing betas better, such as non-market cap-weighted equities. They also include more specialist solutions with niche asset managers, such as reinsurance, currency carry and volatility premiums. Smart Beta solutions have particularly wide applications for most of our clients — regardless of whether they are large or small, or currently investing actively or passively — and our proprietary knowledge and industry relationships have allowed us to help investment managers design much better net-of-fees products for them," Ali said.
According to Towers Watson, institutional demand for global equity and bond mandates has remained high during the past five years, while demand for U.K.-focused equity and bond funds has fallen substantially during the same period.
U.S. and emerging-market bond mandates continued to be popular in 2012, but global bonds were the most popular bond mandate among clients, almost doubling compared to the previous year. In total, bond mandate selections accounted for $24 billion in assets invested last year.
In equities, global mandates continued to be the most popular with Towers Watson's clients, closely followed in popularity by U.S. equity and global ex-U.S. equity mandates. In total, equity mandate selections accounted for $22 billion in assets invested last year.
"These figures confirm an established trend of investors investing away from local markets as they seek to diversify their portfolios more globally," Ali said.
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