Hedge funds have evolved to run non-traditional products such as long-only and liquid alternative strategies to meet new demand from institutional investors, according to the results of a survey by Deutsche Bank which examines the expanding role of hedge funds within the wider asset management industry.

“This study highlights the expanding relationship between institutional investors and the hedge fund managers that have built trusted partnerships and a reputation for delivering strong risk adjusted returns,” said Daniel Caplan, European head of global prime finance at Deutsche Bank.

A fundamental shift is occurring within institutional portfolios: investors are moving away from “traditional” asset allocation in favor of a “risk-based” approach. Investors are incorporating alternatives, including hedge funds, into their core portfolios rather than into a separate “alternatives” allocation, effectively removing any constraints on the percentage allocation to alternative investments.

By the end of 2012, institutional investment accounted for over half (53%) of total alternative assets managed by the top 100 alternative managers globally, with demand expected to increase in the coming years.

The hypothesis is that as institutional investors become ever more comfortable with hedge funds and other alternative investment managers, they will increasingly seek out trusted hedge fund partners to help run not only their alternatives exposure, but their long only portfolios as well.

“An ever increasing number of hedge fund managers are diversifying their product range as they seek to provide differentiated solutions to institutional investors,” said Anita Nemes, global head of capital introduction at Deutsche Bank.

The survey, which received responses from 200 investor entities worldwide managing more than $625 billion in hedge fund assets and 60 global hedge fund managers representing $528 billion in firm wide assets, revealed that over half of investor respondents allocate to non-traditional hedge fund products, including 36% who invest in hedge fund-run long only, and one third investing in liquid alternatives operated by hedge fund managers. One third of all investors increased their allocations to non-traditional hedge fund products last year, and another 43% on average plan to increase their allocations over the next 12 months.

Half of manager respondents now run non-traditional hedge fund products, and 48% of those managers have seen more than half of new business since 2008 directed towards non-traditional hedge fund products.
One fifth of all responding managers have plans to launch at least one non-traditional hedge fund product over the next 12 months, and another 42% are considering it.

Hedge fund managers are crossing over into non-traditional products because clients are asking them to – 67% of responding managers say that demand from existing clients is one of the top three reasons for diversifying the product line.

Evolving investor demand continues to drive growth for liquid alternatives and long only vehicles run by hedge funds: 55% of long only assets managed by hedge fund manager respondents are from institutional investors, whereas retail capital accounts for 54% of assets in alternative ’40 Act mutual fund run by responding managers. Funds of funds and private wealth represent nearly 60% of assets residing in alternative UCITS funds managed by respondents.