Faced with ongoing market volatility, pensions continue to de-risk in 2012, and turn to direct hedge fund programs to make greater returns.

Pensions may seem like a great novelty to many market participants these days. As many pensions nationwide are plagued with a growing number of liabilities but poor funding statuses, private plans especially have turned to defined contribution plans—putting the burden on the individual investor.

Despite this, corporate pension plan deficits increased by $169 billion in 2011 despite $50 billion of individual contributions, propelling them to consider “significant changes in 2012 to better manage volatility.”

“As we think about 2012, expect to see continued challenge around the retirement industry. Plan sponsors are looking for new opportunities to manage long-term volatility,” said Harry Dalessio, senior vice president of retirement institutional relations at Prudential.

“One trend we saw in 2011 was a de-risking of pensions and they continued to be challenged from a balance sheet perspective. We’ll see more of that, as pensions are forced to become more innovative about handling the markets,” he said.

Perhaps one of the leading ways for pensions to innovate is to become bolder about their investment choices, such as a dive deeper into hedge funds.

“Pension funds will be the largest contributor to growth in the hedge fund industry in 2012 as they continue to strive for enhanced risk-adjusted returns in order to decrease their massive unfunded liability,” said Don Steinbrugge, chairman of Agecroft Partners.

Pension funds have historically had a rather plain vanilla, straightforward portfolio, thus, any allocations to hedge funds have been through fund of hedge funds. Not in 2012, noted Steinbrugge.

“More recently, some of the larger pension funds have begun to skip the first step of investing in fund of funds by investing directly in hedge funds, creating long-term implications for the fund of fund industry,” he said, noting that the path towards direct hedge fund programs could last as long as ten years.

Industry-wide, hedge funds will also experience an increase in the average percentage allocation from pension funds.

Despite an increasingly familiarly with hedge funds, many pensions are still wary of these alternative investment vehicles, and are putting more reliance on consulting firms to help perform due diligence and gain insight into specific strategies.

“Many of our clients are asking Mercer to move beyond investment consulting and to assume a greater role in helping them manage their investment programs,” said Phil de Cristo, president and group executive of investments at Mercer.

Though traditionally outsourced, many institutional consultancies, have “become an extension of company staff, despite an outsourced governance model,” de Cristo said.

“Some of our clients may not want internal staff to oversee their alternative investments or other complex investment vehicles, or to monitor fast-moving markets,” he continued. “In other cases, they’ve transitioned to a de-risking model where the speed of decision making is better enabled by outsourcing of implementation.”