Pension Managers Kick Hedge Funds While They're Down

Ever wanted to get inside the mind of an institutional investor? (You could find out answers to questions like this: Why do you agree to pay 2 percent of assets and 20 percent of profits to hedge fund managers who underperform the S&P?)

Well, Citi analyst Prashant Bhatia has done just that. Bhatia polled fifty chief investment officers of pension funds managing more than $1 trillion in assets about their alternative investment decisions. And the verdict? Private equity wins, hedge funds lose.

Among the findings:

-Pension funds expect to increase their allocations in alternative investments from 14 percent of their portfolios today to 20 percent in 2010. (Do they read the same headlines we do, or just ignore them? They plan to increase stakes in real estate and private equity.)

-Private equity, which is third behind hedge funds and real estate today, will jump to number one among alternative investments in three years. (Hedgies will have to learn to fight for their dollars.)

-In the U.S., Blackstone is overwhelmingly their favorite place to put money. (Does this mean BX is a screaming buy? Citi thinks so.)

-Asked what factors influence their decisions, pension managers rank "external consultants" lowest. (Time for a career change, consultants.)

-Most expect to get 10 to 15 percent annualized returns from their private equity investments. They only expect to get 5 to 10 percent from hedge funds, the same as they expect from the S&P 500. (Come again? Could they have lower expectations for the managers they've helped make billionaires? Do their own investors know about this?)

-More than 75 percent believe the fee structure for hedge funds is "not sustainable" over the next five years. (Whew. Sanity rears its head.)

-Of U.S. pension fund managers, more than 90 percent are concerned about the lack of transparency around the valuation of hedge fund investments. (Maybe they should share their troubles with the Treasury Department.)

The report seems to say that, at least in the eyes of pension fund managers, private equity is on the cusp of a boom, and hedge funds were yesterday's news. We wonder how Bhatia's Citi colleague Vikram Pandit is taking it. Pandit is the bank's C.E.O. of alternative investments, and the founder of Citigroup's flagship hedge fund, Old Lane Partners. Perhaps he got on the phone today to appease some of his big pension fund clients after he signed the closing papers for his new $17.9 million Manhattan apartment. After all, Old Lane did lose 5.9 percent in August, and was down 1.9 percent for the year.

Meanwhile, Vanguard's S&P 500 Index Fund, with an expense ratio of just 0.18 percent, was up 5.1 percent for the year at the end of August.

by Megan Barnett