GLOBAL - Institutional investors’ appetite for hedge funds has grown in recent years, but they have taken more time to allocate to the asset class as their expectations of asset managers increases.

According to a report by SEI, in collaboration with Greenwich Associates, institutional investors have become more willing to invest in hedge funds, with more than one-third of them - out of the 105 institutions surveyed - planning to increase target allocations over the next 12 months.

The study, entitled ‘The shifting hedge fund landscape: Institutions put fund managers to the test’, also revealed that most respondents are focusing increasingly on non-correlated investment strategies.

However, this number is lower than in recent years, while institutional investors’ standards for selecting fund managers are rising.

The report pointed to a “real need” for hedge fund managers to help clients better understand their investment strategies, performance expectations and the tradeoffs between risk and reward to maintain investor confidence and attract new capital.

Rodger Smith, managing director at Greenwich Associates, said: “Although returns are understandably a top objective, risk management also remains at the front of investors’ minds.

“Three of the top four goals named by respondents - accessing non-correlated strategies, diversification and lowering volatility - address investment risks.

“This suggests institutions today use hedge funds to help them lower portfolio risks in addition to boosting returns.”

While average annualised returns were down to 6% in 2011 from 9% in 2010, only 7% of investors polled reported any level of dissatisfaction with performance.

According to the study, hedge funds are growing in popularity as volatility reaches record highs and returns in many asset classes plummet.

Philip Masterson, head of business development for Europe at SEI’s investment manager services division, said: “Investors are clearly looking for better returns, but they are also demanding a higher degree of overall risk management.

“To stand out and attract investors, managers will have to be more forthcoming -not just in how they are enhancing their investors’ returns, but [how] they manage the portfolio’s risk exposure.”