What are the most critical challenges facing institutional investors entering 2010? After enduring over two years of market volatility, it is not surprising that risk management was found to be the most widespread concern of respondents of the Pyramis Pulse European Pension Insights survey, developed in conjunction with and conducted by FT Mandate and Professional Wealth Management (see Investors look to rebalance portfolios).
The poll of 160 investment officers at private and public pension schemes, insurers and multimanagers in 10 European countries also highlighted concerns about volatility, low returns,  the rising nominal yield environment and funding levels.
Portfolio rebalancing will be high on the agenda in 2010 as our survey showed that, as a result of market dislocation, many investors are now substantially out of their target ranges for certain assets, particularly in equities and alternatives. Around a quarter of respondents want to increase their equity holdings and a similar number want to reduce exposure to equities, to bring their asset allocation back within target ranges. In line with a greater focus on market risk, 20 per cent of respondents intend to increase their allocations to directional long/short strategies and 20 per cent to equity market neutral.
In pursuit of higher returns, a sizeable 41 per cent of investors intend to increase their allocations to emerging market equities. Not a bad choice considering the MSCI Emerging Markets Index returned 71.55 per cent for the year to mid-December. Interestingly, while emerging market stocks are notoriously volatile, the MSCI EM Index was up 7.85 per cent for the 10 years to mid-December – a rather respectable return when com-pared with the negative 1.59 per cent posted by the MSCI World Index over the same period.
It seems that funds-of-hedge funds can look forward to more asset-gathering difficulties in the new year. For while 28 per cent of respondents intend to increase their allocations to hedge funds, only 31 per cent say that funds-of-funds and multi-managers are one of their preferred hedge fund strategies.
That institutional investors are turning their backs on funds-of-hedge funds also comes as no surprise. Although the HFRI Fund-of-Funds Composite Index was up 10.85 per cent for the year to end November 2009, such performance appears to hold little sway with investors more concerned about the persistent structural issues of high additional fees, liquidity mismatching and transparency.
For instance, the £26.8bn (€29.7bn) Universities Superannuation Scheme (USS) in the UK started investing in hedge funds in 2009, and in so doing has eschewed funds-of-funds in favour of single strategies.
According to Mike Powell, USS’s  head of alternative investments, while hedge fund managers are now aligning their redemption terms with the underlying liquidity of their investments (see Going against the grain), funds-of-funds have yet to address their asset-liability mismatch.
Single hedge fund strategies, as measured by the HFRI Fund Weighted Composite Index, have also outperformed funds-of-funds, gaining 18.8 per cent in the year to end November 2009.
However, hedge fund fees remain stubbornly high, with HFR reporting in December that the average management fee levied across all strategies was 1.58 per cent. The average performance fee stood at 19.21 per cent, with incentive fees declining in macro and value strategies, but rising in equity long-short and event-driven.
Hedge fund practitioners will argue that investors are prepared to pay high fees for high performance. But if stellar performance is not sustained in 2010, investors will be right to ask questions or, better still, to let their feet do the talking.

Henry Smith, editor
henry.smith@ft.com

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