Institutions Shift Allocations to Combat Market Effects

Institutional investors continued to reduce allocations to U.S. equities through the second half of 2008 and into the first six months of 2009, and they remain committed to significant allocations of hedge funds, private equity and other alternative investments, Greenwich said in a press release.

The survey indicates corporate plan sponsors are moving to reduce the volatility of pension fund investment performance by increasing allocations to fixed income, even as they shut defined benefit plans to new employees and reduce matching contributions to defined contribution plans.

Because public funds are not subject to the same accounting rules that govern corporate pensions, they are accepting greater levels of short-term volatility and lower levels of liquidity in return for the chance to make up for last year’s setbacks with strong investment returns. As such, fewer public funds are shifting assets into fixed income and more are increasing allocations to alternative asset classes with higher potential for returns, according to the press release.

After finding themselves forced to sell assets into a falling market in order to fund operations, grant obligations and other needs during the crisis, endowments and foundations are revising their views on cash holdings and increasing liquidity requirements within their portfolios.

However, the survey shows endowments and foundations are giving no signals that they are reconsidering investment policies that emphasize diversification and incorporate relatively high allocations to hedge funds, private equity and other alternative asset classes – 44% of endowments and foundations have actually increased their allocations to hedge funds over the past 12 months.

Endowments (45%) and public pension funds (roughly one-third) have been the first movers among U.S. institutions in making opportunistic investments related to the market crisis. Almost a quarter of U.S. institutions overall have already made investments in opportunistic funds, including vehicles looking to exploit what could be once-in-a-generation opportunities in fixed income, secondary private equity and other asset classes, Greenwich said.

More than 20% of U.S. institutions have shifted assets from active managers to passive strategies in the past year, and almost half of U.S. institutions have scaled back their securities lending programs after discovering unexpected levels of risk during the market dislocations of last year.

The Greenwich survey suggests manager turnover could reach historic highs over the course of the next 12 months if institutions follow through on their plans for managing hiring and firing. Managers can expect tough new demands for increased transparency and disclosure.

Respondents to the survey included 97 corporate pension funds, 34 public funds, and 21 endowments and foundations with AUM greater than $1 billion.