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16 Nov 2006

New Frontiers of Risk: The 360° Hedge Fund study

According to a report by the Bank of New York, pension plans and nonprofit organizations worldwide are attracted to hedge funds because of the losses that pension plans suffered in the equity bear market after 2000.

The study, “New Frontiers of Risk: The 360° Risk Manager for Pensions and Nonprofits,” found that while market risk remains the foremost concern for plan sponsors, managers are now spending close to 40% of their risk-related time on operational and political considerations, an increase of nearly 20% from five years ago, and about 80% indicate they will increase the time spent on operational risk over the next five years.

The report predicts that by 2010, institutions will put half of the assets directly into a hedge fund and the other half through a fund-of-fund platform. As institutional clients become more confident about investing in the $1.7 trillion hedge fund industry, these clients will increasingly demand that fund-of-hedge-fund companies give tailor-made advice and consultancy service in order to justify their fees.

The Bank of New York and Casey, Quirk & Associates report predicted that institutional investors like pension plans and insurance firms will hold more than $1 trillion of assets in hedge funds by 2010, up from $360 billion now.

According to the study, several factors are influencing the popularity of hedge funds, including the widespread under funding of pension funds. More than half of the participants categorized their funds as “under-funded”.

“The study shows that investors increasingly recognize the non traditional risk factors associated with the global investment landscape. The challenge for all organizations will be embracing this new 360° view and taking the formal steps necessary for eliminating, transferring or managing critical risks,” said Debra Baker, managing director and head of Global Risk Services for The Bank of New York.

The study found that plan sponsors such as hedge funds can ably evaluate fund-wide allocation decisions, broadly monitor market risks, and tap new asset classes with more security and knowledge than ever before. Working together, hedge funds and industry providers are developing advanced analytics and reporting required to quantify risk level and focus on interventions.

Results were compiled from surveys of more than 75 representatives from leading pension institutions and nonprofit organizations from around the world. It is the latest in a series of studies conducted by The Bank of New York, including ones on institutional demand for hedge funds.