EUROPE - Pension funds are still willing to pay '2/20' hedge fund fees, but they are becoming increasingly analytical when it comes to finding managers who can provide the right source of alpha, according to Deutsche Bank.

The bank's latest alternative investment survey - in which more than 400 investors participated worldwide - found that pension funds were seeking to increase allocations to hedge funds in the coming months as part of their diversification plans.

However, pension funds have become increasingly concerned about the alpha that hedge funds provide.

Anita Nemes, global head of capital introduction at Deutsche Bank, said: "Performance continues to be key, and an increasing number of institutional investors recognise the added benefits hedge funds offer to their portfolios.

"An impressive 80% of institutional investors either grew or maintained their hedge fund holdings in 2011 in a bullish endorsement of the hedge fund industry."

Nemes added that pension funds were becoming much more "analytical" when it came to finding hedge fund managers who would provide the "right source of alpha".

"The main reason for not paying 2/20 fees is the predominance of beta over alpha," she said. "Fund managers who can provide risk-adjusted returns will have a better chance of achieving higher fees, as investors will become more and more demanding depending on the kind of beta the hedge fund provides."

Nemes said a changing investor base that had become "more institutionalised over time" had driven consolidation.

"Pension funds want a solution according to their funding problem and therefore ask for more transparency and a better operational structure," she said. "This can be easier to achieve for large hedge funds."

In total, 51% of the investor entities surveyed said they had renegotiated their fees within the last 12 months.

Performance remained the predominant criterion for manager selection, with investors being committed to seeking talented, top-performing managers irrespective of size, according to the survey.

In addition, the survey found that 63% of respondents wished to allocate to smaller managers who manage less than $1bn (€744m) in assets.