From a survey of 392 investors that collectively manage and/or advise over $1.35 trillion in hedge fund assets, Deutsche Bank has drawn several conclusions regarding the profile of investors, where they are looking to invest and what current concerns they have about financial markets.

− Almost half the investor respondents manage and/or advise on $1 billion or more of hedge fund assets.

− The majority of respondents have more than seven years of experience in hedge fund investing.

− The industry consolidation continues: investors continue to allocate to the larger funds. There is, however, continued interest in smaller funds, with 65% of investors planning to allocate to firms with less than $1 billion in 2012.

− Investors’ cash holdings of between 10-30% are expected to halve in the next six months, potentially adding an additional $39 billion to the industry.

− Performance continues to be of critical importance for hedge fund investors, particularly as market volatility and an uncertain macro environment becomes the new norm.

The global hedge fund investor base
The amount of hedge fund assets that respondents manage and/or advise on has seen considerable growth since we first introduced the survey. In 2002, 41% of our respondents had only $1 million – $5 million invested in hedge funds. Today, nearly half of all respondents have over $1 billion in hedge fund assets under management, while only a marginal 12% of respondents have less than $100 million – a remarkable transformation over the 10 years that we have conducted the survey (see Fig.1).

As we have seen in the last few years, the majority of investors continue to manage between $1 billion and $5 billion in hedge fund assets. This, we believe, is a testament to the institutionalisation of the hedge fund industry. In 2012, nearly 80% of all respondents have more than seven years of investing experience, and well over half have been investing in hedge funds for over 10 years (see Fig.2). This helps to explain the enormous growth that we have seen in assets under management. As investors gain experience in hedge fund investing and become more familiar with the benefits that hedge funds can offer to their portfolios, they are more comfortable with increasing their allocations and strengthening their commitment to hedge funds. It is interesting to compare these statistics with those from 2003, when a third of our respondents had less than five years of experience in hedge fund investing.

While the hedge fund landscape has dramatically changed and the industry has witnessed incredible growth, the reasons for investing in hedge funds have remained relatively unchanged. Investors continue to report that better risk-adjusted returns are the primary reason for investing in hedge funds, with nearly 70% of respondents citing this as a top reason in 2012. Against the backdrop of a difficult year for global markets, investors remain confident that hedge funds can deliver capital preservation along with reduced volatility. Diversification also remains a primary reason for investing in hedge funds, ranking in second place behind better risk-adjusted returns. It was interesting to see low correlation drop to fourth place this year, with 46% of respondents choosing it as one of the most critical factors compared to 66% in 2011 (see Fig.3 and Fig.4). This, we believe, does not signal a long-term change in investor sentiment but rather reflects a short-term response to a market environment in which observed correlation among various asset classes was generally high.

Investors continue to commit capital to managers with more than $1bn in assets under management, with a preference for managers in the $1 billion – $5 billion category. The number of investors allocating to managers with $1 billion or more is 44%, remaining relatively unchanged from 2011 and 2010, and up significantly from 25% in 2009. Not surprisingly, 62% of institutional respondents invest in managers with $1 billion or more under management (see Fig.5).

Industry consolidation continued in 2011, with the largest hedge fund managers (assets greater than $5bn) raising nearly $51 billion (versus an estimated $45 billion in 2010). This, we believe, is due to several reasons. To begin, there were a few large, well-established managers that out-performed in 2011. In an industry where better risk-adjusted returns are the top investment criteria, it makes sense that these funds would raise the majority of capital. Furthermore, as an increasing number of institutions choose to go direct with their investments, selecting a well-established fund with a long and proven track record seems like a natural first step. At the end of 2011, approximately 5% of hedge funds manage 90% of total hedge fund assets. We expect this trend to continue in 2012. However, we still see significant interest in smaller managers. This view is supported by the responses we received to the following question.

Similar to last year, 65% of respondents plan to invest in firms with lessthan $1 billion under management in the next 12 months. Again, the single most popular response in 2012 was for firms with AUM between $500 million and $1 billion; 36% of funds of funds, 42% of family offices, and 33% of private banks expressed interest in allocating to smaller funds in the coming year (see Fig.6). Given these findings, we maintain the view that the investor searches for smaller and mid-sized managers will continue in 2012, particularly as larger managers reach capacity and end-allocators look to smaller and more nimble funds for new sources of alpha.