GLOBAL - Pension funds are going into hedge funds like lemmings, according to the International Monetary Fund's research chief Raghuram Rajan.
"Myriad new unseasoned hedge or commodity funds are started precisely to exploit the distorted incentives of the pension or insurance fund managers who queue like lemmings to dutifully place the public's money," Rajan said in a speech.
"Thus far losses from isolated failures have been washed away in diversified portfolios and the public has not noticed. Will this always continue?"
Rajan, the IMF's Economic Counsellor and Director of Research, was speaking at a conference on ‘International Financial Instability' organized by the Federal Reserve Bank of Chicago.
He cited the fact that state pension funds were invested in a "risky" hedge fund like Amaranth, whose losses hit European funds like AP7.
He acknowledged that diversifying into alternatives "can be a valuable component of an overall investment strategy if it is carefully thought out".
But he said: "The problem is that all too often, it takes place as a form of herding and late in the game - after lagging pension managers see the wonderful returns in energy or from writing credit derivatives made by their more competent or lucky competitors, there is pressure on them to enter the field.
"They do so late, when the good hedge- or commodity funds are closed to investment, and when the cycle is nearer peak than trough."
Elsewhere, ratings agency Fitch issued a report saying fund of hedge funds "are facing increasing pressure from investors to demonstrate their investment capabilities".
As a result of recent disappointing performance, investors were "re-assessing the value proposition offered by fund of hedge funds".
"Over the last two years, there have been some interesting market events like the General Motors credit crisis in May 2005 and equity market drawdown in May 2006, which have had a significant impact on hedge funds' performance," said Fitch analyst Stephane Scimone.
"These events have also raised questions among investors about the total return attribute of hedge funds.
"More importantly, the diversification among hedge fund managers and of their strategies did not yield the full benefits expected by investors, with many funds of hedge funds producing negative returns."