EUROPE - Institutional investors’ allocations to European funds of hedge funds are growing rapidly, according to a study by Edhec Group, one the leading French Business Schools. But high net worth investors still represent the main category of investors.

“The growing importance of institutional investors is leading to a greater concentration on diversification rather than absolute return,” says Edhec, who conducted the survey into alternative multimanagement in the second half of 2002, to which there were 61 funds of hedge funds manager respondents, managing 136 billion euros at the time.

Another consequence of institutional interest is that there is greater emphasis on benchmarking and a requirement for greater attention to be paid to operational risks.
Edhec comments that operational risks represent the most significant source of hedge fund failures.

The study says that funds of hedge funds managing less that 200 to 300 million dollars will be challenged to “undertake a satisfactory operational due diligence both in terms of skills and economics”.

The use of indices as benchmarks is not without problems, Edhec points out, saying they suffer from numerous biases “mostly related to the absence of regulation in the publication of performance and composition”.

The study lists pairs of indices showing the measurement variance for different strategies over five years, giving as an example for long/short equity strategies, the variance between the two extreme index measurements as 22.04%.

The survey results throw doubts on some of the funds of funds groups’ technical proficiency: only 13% combine a quantitative approach with a qualitative portfolio construction; the number of funds in European hedge of funds were above optimal; while 82% consider the Sharpe ratio, only 4% calculate an Omega ratio, which is more appropriate for alternative.

Only 13% of the survey’s 61 respondents have implemented certification by an independent third party. Such certification, comments Edhec, significantly reduces the failure rate.

The Edhec European Alternative Multimanagement Practices Survey was sponsored by Fimat Group Global Fund Services. Edhec is the largest of the major French business schools, with campuses in Lille and Nice. The survey was supplemented by analysis and interviews earlier this year.