jpm cap intro 2011
TRANSCRIPT
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2011 Investor Sentiment ReportRegeneration: Entering a Period o Sustainable Growth
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This report is published by J.P. Morgan Prime Brokerage
For further information, please contact:
Chris Kapsaroff, Global Equities Client Strategy
212 272 1740
Louis Lebedin, Global Co-Head of Prime Brokerage
212 272 8582
Andrea Angelone, Global Co-Head of Prime Brokerage
44 207 779 2647
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Table o Contents
Executive Summary 1
Itroductio Letter 3
Overview: From Retrechmet to Sustaiable Growth 4
I. The Case or Hedge Fuds (ad Istitutioal Capital) 6Investor Allocations in 2011
Hedge Fund Perormance, Cumulative and Risk-Adjusted
The Increasing Importance o Hedge Funds or PensionsInvestment Priorities
II. Regeeratio 9Three-Phased Cycle
Hedge Fund Net Asset Flows
Institutional Investors Making the Largest Allocations Ever
Cash Positions, Redemptions and Investment Durations
Investor Exposure by Strategy
III. Proceedig with Cautio 13Fund o Funds and Consultants - Blurring the Lines
Investment Priorities
Track Record
Increased Due Diligence
Greater Liquidity and Risk Transparency
Interest in UCITS and Managed Accounts
IV. Balace o Power 20Shiting o Power between Investors and Managers
Renegotiations and Redemptions
V. Lookig Ahead 22
Overview o the J.P. Morga CIG: Istitutioal Ivestor Survey, 2011 23
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2011 InVESTOR SEnTIMEnT REPORT | 1
We believe that the hedge fund industry is entering the
third phase of a three-phase cycle, one that will be
characterized by moderate but sustainable growth, an
increased concentration of assets to established managers
and a stronger control environment.The rst phase began
with the sharp retrenchment o 2008 and continued through
the redemption-plagued months o early 2009. The second
was a period o extensive reallocation that we saw over the
course o late 2009 and 2010. The third phase will, in our
view, see signicant capital inows to the largest unds,
with a greater willingness on the part o investors to place
capital with established managers in emerging investment
vehicles. We also expect to see established managers grow
by acquisition as they seek smaller, standalone managers who
have been successul but have not been able to grow enough
to move to the next level.
For institutions, the hedge fund investment thesis still
holds. Institutional investors have indicated that they are
seeking superior risk-adjusted returns and diversication
rom their hedge und investments [ J.P. Morgan Asset
Management Alternative Assets Survey, 2010]. For the most
part, they are happy with the results they are getting.
Institutions now allocate more assets than ever beore to the
hedge und segment; they are more comortable with hedge
und strategies and better able to shape the terms o their
relationships with managers. Institutional investors appear to be investing with more
conviction. The great reallocation o 2010 has begun to wind
down. In 2008, 90% o our respondents had some portion
o their capital locked up or gated. By the end o 2010,
that gure had allen to 66%. Investors now appear to be
deploying new capital to the hedge und segment. Overall,
95% o respondents indicated that they would be increasing
their allocations to hedge unds in 2011, and many are now
willing to place capital with smaller unds. Strong asset ows
in the rst quarter o 2011 appear to be bearing this.
But they also remain cautious. In an eort to make more
inormed investment decisions, institutional investors
demanded improved transparency, liquidity and control in
2009. Overall, institutional investors perormed more due
diligence, required more thorough risk transparency and
requested shorter lock-ups and more requent redemption
periods. However, the required level o liquidity appears
to depend on investor type and geographical location. For
example, only 11% o North American respondents required
monthly redemption withdrawal periods, versus 38% in Asia
and 39% in Europe. Risk transparency seems to be critical
to almost all institutional investors as 94% o respondents
require at least summary inormation rom hedge und
managers on a regular basis.
The implications for hedge fund managers have not
changed. When looking to select a hedge und manager,
our respondents ranked Experience/Pedigree o Manager,
Investment Strategy, Perormance/Track Record and Risk
Management as the most important criteria or allocation.
We think that these results reafrm investors singular
ocus on perormance. Assets owed to the largest, most
proessionally managed unds. As established managers
who had opened up to new investor capital in 2009 have
begun turning away investors, our respondents indicated
that they had a growing interest in smaller and newer unds,
particularly by amily ofces, und o unds, consultants and
wealth management companies.
Several important areas of tension between institutional
investors and hedge fund managers persist. Over the
past several years, we have seen the power relationship
between investors and hedge unds evolve. Large investors
pensions, endowments and oundations, in particularhave
demonstrated the ability to drive change with the largest
impact on smaller hedge unds. Our analysis o hedge und
managers conrms that the majority o unds responding to
these demands were primarily smaller or newer managers.
However, through ollow-up conversations, we ound that
larger unds did succumb to investor demands when largeallocations were on oer. As investors reallocated into larger,
better perorming unds in 2010, they also strengthened the
position o what were already the most powerul managers.
Our studies show that these managers, many o whom
have actually turned away investors, are much less likely
to give investors the kind o transparency and liquidity
that they seek. Moreover, top perormers report that their
management and perormance ees remain where they were
beore the crisis.
The roles of consultants and funds of funds are evolving.
Since the rst quarter o 2010, we have witnessed hedge
und net asset ows grow by over $55 billion. Over the sameperiod, und o unds net asset ows ell by nearly $11 billion.
We believe that this signals a shit away rom investors use
o und o unds vehicles as they begin placing capital
directly into unds as opposed to placing money with und o
unds. The J.P. Morgan Capital Introduction Group: Institutional
Investor Survey, 2011 (known rom here on orward as CIG:
Institutional Survey 2011) revealed that investors expect to
hire consultants or investment expertise, while 9% o und
o unds expect to start providing advisory/consulting
services in 2011.
Executive Summary
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2011 InVESTOR SEnTIMEnT REPORT | 3
Introduction Letter
In the rst quarter o 2011, J.P. Morgans Prime Services Capital Introduction Group completed its survey o more than 300 o
the worlds leading institutional investors. Participant responses were thought-provoking and suggested that their behavior in2011 will dier rom 2010 in important ways. In order to urther test our central hypotheses, we also incorporated ndings rom
original studies perormed by the Prime Services and Asset Management divisions o J.P. Morgan, as well as those published by
selected third parties. This report describes our analysis and ndings.
Last year, we argued that changes in investor sentiment were driving a major shit in the allocation o institutional assets among
hedge unds that would redene the competitive landscape. We think the results o this years survey conrm that the great
reallocation that we posited in the 2010 report happened and has largely run its course. Institutional investors appear to be
cautiously optimistic. Hedge und managers have responded to investor demands in some constructive ways. In our view, the
hedge und industry is now entering the third phase o a three-phase cycle, one that will be characterized by moderate but
sustainable growth, an increased concentration o assets to established managers and a stronger control environment.
We hope that hedge und managers, investors and other market participants nd this report useul. We welcome any comments
that you may have regarding our views.
Best regards,
Louis Lebedi
Adrea Ageloe
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4 | Prime Brokerage
In last years report, we described a hedge und industry that,
on the surace, appeared to have rapidly rebounded rom the
nancial crisis and was positioned or a period o sustained
growth. The major hedge und indexes showed better risk-
adjusted return characteristics than most asset classes, and by
the beginning o 2010, net ows had begun to turn modestly
positive. Our survey conrmed that institutional investors
would continue to take a leading role in the hedge und
industrys repair, with 91% reporting they intended to increase
their allocations to the segment over the course o 2010.
Within the hedge und asset base, however, we believed that
a massive reallocation o capital was underwayone that we
elt would have important implications or the types o hedge
unds that would be successul in the uture.
By our estimates, more than a third o the hedge und asset
base was in motion by mid-2010. What was driving this
tectonic shit in the structure o the industry? In our view:
dierentiated perormance. A relatively small number o the
most proessionally managed unds outperormed hedge
und indices while maintaining liquidity or investors, while
during the same period, large numbers o smaller, less adeptly
managed hedge unds underperormed or ailed entirely.
Over 600 unds liquidated in 2010, more than double the
10-year average leading up to the nancial crisis. This shows that
there is still a very high level o attrition among unds [HFR Year
End 2010 Industry Report]. We ound that institutional investorshad begun to manage their positions ar more aggressively.
In all, 89% o the respondents to our institutional investor
survey last year said that they had redeemed some portion o
their hedge und investments, while many more indicated that
they would have redeemed but were still locked up in poorly
perorming vehicles as o the date o our survey. We ound
that as these investors reed up captive capital, they quickly
reallocated it to the managers that had proven their ability
to perorm through the cycle.
We believe that industry asset ows bear this thesis out.
From late 2009 through 2010, net inows to the hedge
und segment were positive but well below the average
inows o the 10 years leading up to the crisis. However,
the concentration o assets with the largest hedge unds
increased signicantly during this period. In 2004, hedge
unds managing more than $1 billion in assets accounted
or 65% o the industrys global asset base. By the ourth
quarter o 2010, that gure had surged to 84% [Hedge
Fund Intelligence, Global hedge fund assets up 11% in 2010and back above $2 trillion]. Our survey responses
or 2010 also bear this thesis out: 75% o respondents cited
redemptions as a source capital or their new hedge und
investments, and most o their investments were directed
toward the largest managers.
In last years report, we maintained that the implications
o our ndings or hedge und managers were clear. Risk-
adjusted perormance mattered above all else; it was the
#1 selection criteria or investors. We also ound that top
perorming managers oten had investors competing or a
limited number o allocations, enabling those managers to
have greater leverage in negotiating terms around liquidity
and transparency. Size also mattered. The largest unds
generally proved to be more scalable, more controlled and
more attractive to investors rom a perormance perspective.
Running multiple strategies within a und amily, but not within
a specic und, also helped to improve perormance and
attract capital rom investors seeking diversication. Finally,
proessionally operated unds that employed institutional
caliber controls and were capable o managing multiple prime
brokers were most likely to attract investors.
This years report is based on the J.P. Morgan Prime
Services Capital Introduction Groups survey o 363 o the
worlds leading institutional investors. The primary research
was conducted over the course o the ourth quarter o 2010
and rst quarter o 2011. In order to test additional hypotheses
and better explain certain trends, we also incorporated
data rom J.P. Morgans hedge und benchmarking survey
[J.P. Morgan Consulting Group Client Benchmarking Survey] and
analysis rom J.P. Morgans Asset Management division, as
well as select third party studies.
Sources o Capital or new Allocatios to Alteratives (2010)
% responses of total respondents
Source: J.P. Morgan Capital Introduction Group: Institutional Investor Survey, 2011 Figure 1
49%
Reallocated Capital from
Other Asset Classes
77%
Redeployed Capital from
Returned Redemptions,
Lifted Gates, etc.
72%
New Capital
Overview: From Retrenchment to Sustainable Growth
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2011 InVESTOR SEnTIMEnT REPORT | 5
We believe that the hedge und industry is entering the
third phase o a three-phase cycle, one that will be
characterized by moderate but sustainable growth, an
increased concentration o assets to established managers
and a stronger control environment. The rst phase beganwith the sharp retrenchment o 2008 and continued through
the redemption-plagued months o early 2009. The second
was a period o extensive reallocation that we saw over the
course o late 2009 and 2010. The third phase will, in our
view, see signicant capital inows to the largest unds,
with a greater willingness on the part o investors to place
capital with established managers in emerging investment
vehicles. We also expect to see established managers grow
by acquisition as they seek smaller, standalone managers who
have been successul but have not been able to grow enough
to move to the next level. Other key ndings include:
For institutions, the hedge fund investment thesis still
holds. Institutional investors have indicated that they are
seeking superior risk-adjusted returns and diversication
rom their hedge und investments [ J.P. Morgan Asset
Management Alternative Assets Survey, 2010]. For the most
part, they are happy with the results they are getting.
Institutions now allocate more assets than ever beore to the
hedge und segment; they are more comortable with hedge
und strategies and better able to shape the terms o their
relationships with managers.
Institutional investors appear to be investing with more
conviction. The great reallocation o 2010 has begun to winddown. In 2008, 90% o our respondents had some portion
o their capital locked up or gated. By the end o 2010,
that gure had allen to 66%. Investors now appear to be
deploying new capital to the hedge und segment. Overall,
95% o respondents indicated that they would be increasing
their allocations to hedge unds in 2011, and many are now
willing to place capital with smaller unds. Strong asset ows
in the rst quarter o 2011 appear to be bearing this.
But they also remain cautious. In an eort to make more
inormed investment decisions, institutional investors
demanded improved transparency, liquidity and control in
2009. Overall, institutional investors perormed more due
diligence, required more thorough risk transparency and
requested shorter lock-ups and more requent redemption
periods. However, the required level o liquidity appears
to depend on investor type and geographical location. For
example, only 11% o North American respondents required
monthly redemption withdrawal periods, versus 38% in Asia
and 39% in Europe. Risk transparency seems to be critical
to almost all institutional investors as 94% o respondents
require at least summary inormation rom hedge und
managers on a regular basis.
The implications for hedge fund managers have not
changed. When looking to select a hedge und manager,
our respondents ranked Experience/Pedigree o Manager,
Investment Strategy, Perormance/Track Record and Risk
Management as the most important criteria or allocation.
We think that these results reafrm investors singular
ocus on perormance. Assets owed to the largest, most
proessionally managed unds. As established managers
who had opened up to new investor capital in 2009 have
begun turning away investors, our respondents indicated
that they had a growing interest in smaller and newer unds,
particularly by amily ofces, und o unds, consultants and
wealth management companies.
Several important areas of tension between institutionalinvestors and hedge fund managers persist. Over the
past several years, we have seen the power relationship
between investors and hedge unds evolve. Large investors
pensions, endowments and oundations, in particularhave
demonstrated the ability to drive change with the largest
impact on smaller hedge unds. Our analysis o hedge und
managers conrms that the majority o unds responding to
these demands were primarily smaller or newer managers.
However, through ollow-up conversations, we ound that
larger unds did succumb to investor demands when large
allocations were on oer. As investors reallocated into larger,
better perorming unds in 2010, they also strengthened the
position o what were already the most powerul managers.
Our studies show that these managers, many o whom
have actually turned away investors, are much less likely
to give investors the kind o transparency and liquidity
that they seek. Moreover, top perormers report that their
management and perormance ees remain where they were
beore the crisis.
The roles of consultants and funds of funds are evolving.
Since the rst quarter o 2010, we have witnessed hedge
und net asset ows grow by over $55 billion. Over the same
period, und o unds net asset ows ell by nearly $11 billion.
We believe that this signals a shit away rom investors useo und o unds vehicles as they begin placing capital
directly into unds as opposed to placing money with und o
unds. The J.P. Morgan Capital Introduction Group: Institutional
Investor Survey, 2011 (known rom here on orward as CIG:
Institutional Survey 2011) revealed that investors expect to
hire consultants or investment expertise, while 9% o und
o unds expect to start providing advisory/consulting
services in 2011.
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6 | Prime Brokerage
Institutional investors have been steadily increasing their
overall level o investment in hedge unds segment or years.
In 1999, 46% o hedge und capital ows were sourced
through institutions. By 2009, institutions accounted or the
majority o the assets in the space [IFSL, Hennessee Group LLC].
A study by the research rm Preqin in the rst quarter o 2011
highlighted the pivotal role that institutional investors now
play in the industry. Nearly hal o the hedge und managers
they surveyed reported sourcing more than 60% o their
capital rom institutions; 28% reported sourcing more than
80% o their capital rom institutions [Preqin Hedge Fund
Manager Study, Feb. 2011]. In Q1 2011 alone, pension unds
allocated $18 billion to hedge unds; Pensions & Investments
magazine reports that the combined total o net inows and
pending searches is the highest in our years with institutional
investments back to pre-2008 levels.
Institutional capital has become increasingly critical to hedge
und managers as they become larger. Hedge unds managing
$10 billion or more in assets reported that, on average, 67%
o their capital originated rom institutional sources. The
importance o institutional investors is likely to increase in
2011. Analysis by J.P. Morgans Prime Brokerage business
concluded that nearly hal o the hedge unds managing more
than $1 billion in assets, the segment most likely to source an
overwhelming majority o capital rom institutions, plan to add
unds in 2011, and Preqin ound that 84% o its respondents
expect to increase the proportion o their capital base sourced
rom institutional investors.
Global Compositio o Hedge Fud Capital Flows
Source: IFSL, Hennessee Group LLC Figure 2
0%
20%
40%
60%
80%
100%
IndividualsInstitutional Investors
46%
54%
1999
74%
26%
2009
44%
56%
2005
Average % o Hedge Fud Capital rom Istitutioal Ivestors by
Maager AUM (2011)
Source: Preqin Hedge Fund Manager Study, February 2011 Figure 3
>$10 BN$19.9 BN$500999 MM$250499 MM$5 BN
44.7
$15 BN
5.6
(2.8)
$500 MM1 BN
$250500 MM
2.4
$100250 MM
2.2
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2011 InVESTOR SEnTIMEnT REPORT | 7
Are institutional investors getting the results theyre looking
or rom their hedge und investments? Ater all, investors
could simply be chasing returns by rotating capital into hedge
unds because they perormed better than other asset classes.
Hedge unds are an expensive way to generate returns, and theinvestor/manager relationship can be complex. I institutional
investors nd themselves dissatised with the results o their
orays into the space, there could be another major wave o
redemptions. Through primary research, we have ound that
institutional investors mainly seek two things rom their hedge
und investments: superior returns per unit o portolio volatility
and diversication into less correlated asset classes. Through
ollow-up conversations, some managers have increasingly
mentioned capital preservation as a high priority. This
eedback is consistent with the larger stress on diversication
and reduction o volatility [ J.P. Morgan Asset Management,
Alternative Assets Survey, 2010]. It appears that hedge unds
have delivered, though some strategies and managers have
perormed better than others. Looking at returns o pension
und portolios or the one-, three- and ve-year time horizons
dating rom June 2010, Preqin ound that hedge unds
generally outperormed their expectations on a total returnbasis. More importantly, returns or the 12 months ending
June 2010 exceeded the expectation by an average o 365 basis
points. Because these returns were measured in the midst
o a major reallocation o assets, they include trailing data
rom underperorming unds that were later redeemed and,
thereore, probably dampen overall returns. A comparison o
the cumulative returns o major hedge und indexes to those
o major stock and bond indexes conrms the point. A look
at returns rom the 12 months ending December 2010 shows
that 19 out o 25 hedge und strategies outperormed the
major stock and bond indexes on a risk-adjusted basis.
Istitutioal Ivestors Greatest Advatages o Ivestig
i Hedge Fuds (% o respodets)
Source: J.P. Morgan Asset Management, Alternative Assets Figure 6
Diversification
73%
Returns
63%
Volitility of Returns
51%
Media Returs o Public Pesio Plas by Asset Class
as o Jue 30, 2010
Source: Preqin Hedge Fund Manager Study, February 2011 Figure 7
Hedge Funds Listed Equity Private Equity
Real Esta te Tota l Investment Portfol io
Fixed Income
1 Year 5 Years3 Years-15%
-10%
-5%
0%
5%
10%
15%
20%
Cumulative Returs, 20072010
Source: Indices Figure 8
Eureka Hedge Euro Hedge HFRI DJ/CS
HF Index
MSCI World Barc lays Govt/
Credit Index Bond
S&P 500
Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10
40
50
60
70
80
90
100
110
120
130
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8 | Prime Brokerage
For institutional investors capable o securing stakes in top
perorming hedge unds, a number o compelling investment
opportunities exist. For hedge und managers, the institutional
investor base represents an increasingly crucial source o
capital. The opportunity or high quality managers could
be enormous. A Pensions & Investments/Towers Watson
survey in the ourth quarter o 2010 shows the total assets
o the worlds 500 largest institutional investors at nearly
$62 trillion [Pensions & Investments /Towers Watson World
500: The Worlds Largest Money Managers, 10/18/2010].
But allocations to hedge unds remain relatively small.
The percentage o public pension und investments in hedge
unds, or example, has nearly doubled since 2007, but it still
remains at only 6.6% o their total portolios. Hedge und
managers ace a number o signicant challenges when dealing
with institutional investors. Overall, however, we believe that
institutional investors are helping to make the hedge und
segment more transparent, eectively controlled and likely to
deliver superior risk-adjusted returns (more on these points
to ollow). In our view, the case or hedge unds remains a
strong one rom the perspective o most institutional investors.
The case or institutional capital rom the perspective o hedge
und managers has become convincing as well.
HFRI Idex Risk Retur Compariso, 2010
Source: HFR Year End 2010 Industry Report Figure 9
Asset-Backed
EqMktBNtrlMerg Arb
RV: Multi
RV
EM: LatAm
Short Bias
EAFE
MSCI World
Energy
EM: Russia
Emerging Markets
Macro
EM: Global
Yield Alts
S&P 500
0 5 10 15 20 25
(25)
(20)
(15)
(10)
(5)
0
5
10
15
20
FI Corp
Barclays Govt/Credit
EHConv Arb E-D
FWC
Reg D
Distressed DJ/CS HF
FOF
Quant/DrectnlMacro: Sys Div
EM: Asia ex-JapanTech/HC
Standard Deviation (%)
Return(%)
Public Pesio Fud Allocatios to Hedge Fuds, 2007Preset
Source: Preqin Hedge Fund Manager Study, February 2011 Figure 10
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%
Q1 2011
6.6%6.5%
Q4 2010Q4 2009
6.0%
Q4 2008
5.7%
Q4 2007
3.6%
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2011 InVESTOR SEnTIMEnT REPORT | 9
We believe that the hedge und industry is entering the third
phase o a three-phase cycle, one that will be characterized by
sustainable growth, increased concentration o assets and a
stronger control environment. The current cycle began in 2008,
with the retrenchment in global markets. Hedge unds assets
declined by 31% between the second quarter o 2008 and the
rst quarter o 2009. In the aggregate, they outperormed
most asset classes. Overall, hedge unds provided better
total returns than equities and better risk-adjusted returns
than bonds throughout the crisis. Still, rom the third quarter
o 2008 to the ourth quarter o 2009, investors withdrew
over $329 billion [HFR Third Quarter 2009 Industry Report]. In
previous studies, we ound that much o the capital outow was
driven by high net worth investors that required liquidity or a
variety o reasons, not all o them related to the perormance
o their hedge unds positions. By the second hal o 2009, the
hedge und asset base was sourced primarily rom institutional
investors and high net worth individuals that took a long-
term view. The act that many institutional investors saw
hedge unds as an attractive investment class does not mean
that they were particularly satised with the hedge und
position that they actually held. This brought about the
second phase o the current cycle: reallocation. Over the
course o late 2009 and early 2010, we believe that more
than a third o all hedge und assets were in motion
[Tectonics: Shifting Investor Sentiment and the Implicationsfor Hedge Fund Managers, J.P. Morgan Prime Brokerage,
September 2010]. Most o the capital in ight during this
period did not appear to be new money coming into the
hedge und space but rather, existing capital being shited
rom managers that underperormed during the crisis to
those that outperormed. From the rst quarter o 2009
through the ourth quarter o 2010, hedge und assets
increased by $586 billion, a growth o 44% [HFR Year End
2010 Industry Report]. However, all o that growth came
rom manager perormance; investors pulled out a net o
$76 billion during this period [HFR Year End 2010 Industry
Report]. Capital ows turned positive in the second hal o2009, but since then, quarterly new investment has been
modest, averaging 3.5% o global AUM versus the 20002008
average o 10.4% [HFR Year End 2010 Industry Report].
Entering 2011, we believe that institutional investors are
cautiously optimistic about, and increasingly demanding o, the
hedge und segment. This year, 95% o CIG: Institutional Survey
2011respondents said that they intend to make new allocations
to hedge unds in the coming 12 months. This gure increased
rom 88% in 2009 and 91% in 2010. The average size o hedge
und allocations has already begun to increase; the percentage
o CIG: Institutional Survey 2011 respondents making average
allocations o at least $25 million improved rom 18% in
2008 to 32% in 2010. Pension, endowment and oundation
managers, as well as large insurers, were the investors
most likely to make these large placements. The majority
o CIG: Institutional Survey 2011 respondents indicated that
they plan to increase the number o hedge unds they invest
in over the next 12 months as well. Interest was particularly
strong among pension, oundation and endowment managers,
71% o whom indicated that they will increase the number
o hedge unds into which they have made placements.
Additionally, we ound that many o the largest pensions,
particularly in North America, remained signicantly
underunded and see hedge unds as a way to build back
Three-Phased Cycle: The Hedge Fud Eviromet, 20082011P
Source: HFR Year End 2010 Industry Report Figure 11
Q12011
Q22011
0.00.20.40.60.81.01.21.41.61.82.02.2
Q12008
1.88
Q22008
1.93
Q32008
1.72
Q42008
1.41
Q12009
1.33
Q22009
1.43
Q32009
1.54
Q42009
1.60
Q12010
1.67
Q22010
1.65
Q32010
1.77
Q42010
1.922.01
Retrenchment Reallocation Regeneration
$
Billions
Global Asset Ifows/Outfows, 20002010
Source: HFR Year End 2010 Industry Report Figure 12
Average inflowsof total assets
3.5%
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
(200)
(150)
(100)
(50)
50
100
150
200
250 Average inflows
of total assets
10.4%
$
Billions
II. Regeneration
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10| Prime Brokerage
their asset base. More than two-thirds o consultants,
an increasingly important market participant, indicated thatthey would also be increasing the number o unds that they
placed with.
Investors are positioned to act. Fewer now nd themselves
invested in hedge unds that have redemptions suspended
or gated. In the CIG: Institutional Survey 2011, 66% o
respondents reported that some percentage o their portolio
was subjected to these provisions, but nearly 90% had less
than 10% o their capital held up. More than 80% o CIG:
Institutional Survey 2011 respondents reported that they have
less than 10% o their portolios in cash, whereas in 2008,53% had more than 10%, indicating that they have begun to
put capital to work. In 2009, 18% o CIG: Institutional Survey
2011 respondents reported that 75% o their hedge unds
had returned to their high water marks. This year, hal o the
CIG: Institutional Survey 2011 respondents said that at least
75% o the managers that they invested in had reached their
high water marks.
Percetage o Respodets Itedig to Allocate to Hedge Fuds
(20092011E)
Source: J.P. Morgan Capital Introduction Group: Institutional Investor Survey, 2011 Figure 13
2009
88%
31%
2010
91%
45%
2011 Expected
95%
53%
Increasing # of HF InvestmentsIncreasing Total Allocation
Ivestors Makig Average Allocatios to Hedge Fuds Greater Tha $25MM
Source: J.P. Morgan Capital Introduction Group: Institutional Investor Survey, 2011 Figure 15
2009
22%
18%
32%
20102008
Wealth Manager Insurance Company Fund of Funds Famil y Oce Endowments, Foundations and PensionsOther BankConsultant
Percet o Hedge Fuds Subject to Gatig or Lock-Up Provisios
(20082010)
Source: J.P. Morgan Capital Introduction Group: Institutional Investor Survey, 2011 Figure 14
2010
66%
2009
84%
2008
90%
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2011 InVESTOR SEnTIMEnT REPORT | 11
How are investors acting on their sentiments? We ound that
the majority o them are taking a long view. Overall, 90% oCIG: Institutional Survey 2011 respondents reported that
the duration o their typical hedge und investment is longer
than two years. Most reported that the typical duration is two
to ve years. However, 25% stated that their typical investment
in hedge unds is held or more than ve years. This shows a
marked increase rom the 16% that gave the same response
in 2008, when redemptions were quite common. We also
ound that investors with more experience investing in hedge
unds tend to make larger placements. In the CIG: Institutional
Survey 2011, investors with more than 10 years o experience
managing hedge und positions accounted or only hal o
our respondents, but 70% o the assets placed. Conversely,
those with ewer than three years o experience placed only
2% o the capital. In all, 48% o CIG: Institutional Survey 2011
respondents with more than 10 years o experience reported
that the size o their average hedge und investment was
larger than $25 million. For those with one to three years o
experience investing in hedge unds, only 6% reported an
average allocation o more than $25 million. No respondents
with less than a year o hedge und investing experience made
placements larger than $25 million.
As we have ound in previous research, investors responding
to the CIG: Institutional Survey 2011 had disparate views onwhich strategies they will be allocating toward in the coming
months. There were, however, our overarching themes. First,
respondents clearly identied several strategies o interest;
between 20% and 25% indicated that they will increase their
allocations to macro, event driven, emerging markets and
undamental long/short managers, and 17% slated managed
utures or increases. These gures are roughly similar to
what respondents said last year, though the number saying
they would allocate more to managed utures strategies
decreased by a meaningul amount year over year. Second,
respondents generally agreed that they will reduce their
allocations to two types o strategies in particular. Managers
running multiple strategies within a single und will likely
receive substantially less capital this year, as nearly a quarter
o CIG: Institutional Survey 2011 respondents indicated that
Respodets Hedge Fud Holdigs Gated
or Uder Redemptio Suspesio i 2010
Source: J.P. Morgan Capital Introduct ion Group: Institut ional Investor Survey, 2011 Figures 16 and 17
Cash Positios as a Percet o Total Portolio (2010)
Greater than 25% Gatedor Suspended 2%
1025% Gated
or Suspended 10%
110% Gated
or Suspended 54%
0% Gated
or Suspended 34%
Greater than 50% Cash 1%
2550% Cash 3%
10-25% Cash 14%
5-10% Cash 29%
Less than 5% Cash 52%
Typical Duratio o Ivestmet (20082010)
Source: J.P. Morgan Capital Introduction Group: Institutional Investor Survey, 2011 Figure 18
0%
20%
40%
60%
80%
100%
25 years 12 yearsGreater than 5 years
2008 20102009
74%
10%
65%
10%12%
69%
16% +3% +6% 25%19%
Hedge Fud Ivestig Experiece by number o Respodets
ad AUM Ivested
Source: J.P. Morgan Capital Introduction Group: Institutional Investor Survey, 2011 Figure 19
51%
22%
17%9% 1%
70%
18%
100% 100%
10% 2%
HF Investing Experience
by AUM in HFs
HF Investing Experience
by # of Respondents
710 years 46 years
13 years Less than 1 year
Greater than 10 years
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12 | Prime Brokerage
they would be reducing their allocations to these types o
unds, while only 9% said that they would increase. We mayvery well see these multi-strategy unds lower their
perormance or management ees in order to prevent these
capital outows. Respondents also generally agreed that
they would be reducing their allocations to und o unds,
something that we think will have important implications or
consultants. The third theme derived is that investors are
likely to maintain their current geographic allocations,
which have remained airly constant over the course
o the past three years. The nal theme is dissonance.A quarter o respondents stated that they plan to
increase their allocation to macro strategies, but 19%
said that they plan to decrease. Fundamental long short,
one o the our most popular strategies or new allocations
among respondents, is likely to have an equal number o
investors redeeming. In act, every strategy can expect to
see capital outows to some degree.
Respodets Icreasig/Decreasig Exposure by Strategy (2011)
Source: J.P. Morgan Capital Introduction Group: Institutional Investor Survey, 2011 Figure 20
1%
2%
2%
4%
6%
6%
7%
8%
8%
-10%
-4%
-2%
-5%
-10%
-6%
-4%
-11%
-12%
9%-24%
9%-8%
10%
10%
-9%
-5%
11%-22%
17%-6%
20%-19%
22%
24%
-8%
-10%25%-19%
-25% -20% -15% -10% -5% 0% 5% 10% 15% 20% 25% Net % Change
MacroEvent Driven
Emerging Markets
Long Short Equity: Fundamental
CTAs/Managed Futures
Credit Strategies: Corporate Credit
Commodities
Credit Strategies: Structured Credit
Long Short Equity: Sector
Multi-Strategy
Fixed Income Arbitrage
Long Short Equity: Market Neutral
Long Short Equity: Quantitative
Long Short Equity: Long Biased
Convertible Arbitrage
Options Arbitrage
Long Short Equity: Short Biased
Unhedged Equity: Long Only
Fund of Funds
+6%+14%
+14%
+1%
+11%
-11%
+5%
+1%
+1%
-15%
-4%
-3%
+3%
0%
-4%
-1%
0%
-2%
-9%
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2011 InVESTOR SEnTIMEnT REPORT | 13
Investors expect the roles o consultants and und o unds to
continue evolving. We ound that large investors have begun
to increasingly use consultants to help them invest directly
into hedge unds. In 2010, new capital invested directly into
hedge unds totaled $55 billion. Fund o unds investors saw
capital outows o $11 billion during the same period. Despite
the und o unds outows, we believe that the sector will
continue to play an important role in the industry, but in order
to regain its dominance, it will need to deliver services and
perormance that rationalizes the extra layer o ees. We have
already seen a trend as und o unds begin to blur the lines
with consulting rms and oer additional services. Nearly hal
o the und o unds managers we surveyed launched advisory
services by late 2010, and 83% o them charged a separate ee
or consulting services. In some cases, we have seen und o
unds managers oer the advisory services or ree. However,
we also ound that less than 10% o investors used und o
unds or advisory services.
In our view, hedge unds are well positioned to increase their
share o global investment capital. However, the institutional
investors that we think will be allocating the vast majority
o the new capital are making signicant demands on hedge
und managers. Selection criteria is exacting. Due diligence
is intense. Investor demands or transparency, liquidity and
controls are acute. We believe that these trends are secular,
not simply a hangover rom the crisis period. Overall, we think
that institutional investors will drive improvements through
the upper tiers o the hedge und industry. We also think that
these trends will drive additional costs and behavior changes
into the space.
Fud o Fud vs. Hedge Fud Idustry net Asset Flows
(Q2 2009Q4 2010)
Source: HFR Year End 2010 Industry Report Figure 21
Q2-09 Q3-09 Q4-09 Q1-10 Q2-10 Q3-10 Q4-10
(32.2)
(42.8)
Industry FlowFoF Flow
(3.3)
(11.9)
(2.0)
1.1 2.5
13.8 13.89.5
19.0
0.3 1.8
13.2
III. Proceeding with Caution
Fud o Fud Respodets that
Act as a Advisor/Cosultat (2010)
Source: J.P. Morgan Capital Introduct ion Group: Institut ional Investor Survey, 2011 Figures 22 and 23
Respodets Who Use a Cosultat (2010)
Expect to Start Providing
Advisory/Consulting
Services in 2011 9%
No 43%
Yes 47%
Expect to Start Using One 1%
Yes 17%
No 82%
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We have ound that over the past three years, institutional
investors consistently stress the same criteria when selecting
hedge unds in which to allocate: the managers experience,
pedigree and perormance history, in addition to the specic
strategy employed. Investors cite a number o other issues asbeing highly important to them, such as risk management,
transparency, lock-ups and ees. However, the decision to
allocate does appear to come down to whether the manager
has demonstrated the ability to deliver high quality returns
and whether the strategy employed ts the investors overall
portolio. We ound that or institutional investors, a hedge
unds prime broker is not a top priority in manager selection.
However, it can be a reason not to allocate. Nearly hal o
CIG: Institutional Survey 2011 respondents indicated that
they would decline investing in a hedge und because o the
managers choice o prime brokers. Two-thirds responded that
they would decline investing because o a managers choice
o administrator.
Increasing numbers o CIG: Institutional Survey 2011
respondents have stated their willingness to invest in smaller
unds. In 2010, und o unds, amily ofces and wealth
management companies were the segments most likely
to invest in managers with less than $100 million in assets.
Overall, 69% o CIG: Institutional Survey 2011 respondents
indicated that they would be willing to invest in start-
up hedge unds, though most said that they would do so
selectively. In ollow-up conversations with investors, we
ound that many were interested in smaller unds primarilybecause the largest managers were beginning to close.
Some investors elt that they were being crowded out
o certain hedge und investment opportunities by large
institutions, particularly pensions, endowments, oundations
and insurance companies that were willing to make substantial
placements. Many investors have concentration limits,
and these large institutions are oten orced to ocus their
eorts on the largest managers. Not surprisingly, 43% o
respondents to the CIG: Institutional Survey 2011 who made
average investments o more than $250 million stated that
they required a hedge und to manage assets o more than
$1 billion beore they would consider making an allocation.
A secondary but important motivation or many investors
was the opportunity to take a large stake in a newer vehicle
in its early years, when investing experience suggests
it should have its strongest returns [The Performance
of Emerging Hedge Fund Managers, Rajesh K. Aggarwal
(University of Minnesota) and Philippe Jorion (University
of California/Davis) working paper, January 2008].
Top Priority Whe Selectig a Hedge Fud Maager, 2010
Source: J.P. Morgan Capital Introduction Group: Institutional Investor Survey, 2011 Figure 24
+3%
+1%+2%
+1%
+4%
-2%-1%
-3%
-1%
-2%
Experience/Pedigree of Manager
Investment StrategyPerformance/Track Record
Risk Management
Drawdown Statistics
Transparency
Lock-up Provisions
% of Liquid Net Worth ofManager Invested in the Fund
Leverage
Other
0%YoY % Change 10% 20% 30% 40%
Ivestors Willig to Ivest i a Start-Up Maager (2010)
Source: J.P. Morgan Capital Introduction Group: Institutional Investor Survey, 2011 Figure 25
Yes 10%
No 31%
Selectively 59%
Miimum AUM Required to Ivest i Fud (20092010)
Source: J.P. Morgan Capital Introduction Group: Institutional Investor Survey, 2011 Figure 26
$0 MM $50 MM $100 MM $250 MM $500 MM $1,000 MM
20102009
25%
37%
27%
15%
27%
13%
24%
14%
4%8%
0%
10%
20%
30%
40%
4%2%
Hedge Fud Perormace by Age o Fud
Source: The Perormance o Emerging Hedge Fund Managers, 2008 Figure 27
0.38%
3-9 years
9.15%
2.71%
02 years
10.08%
Average AlphaAverage Return
0%
6%
4%
2%
8%
10%
12%
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2011 InVESTOR SEnTIMEnT REPORT | 15
Interest in investing in smaller unds, however, does not
appear to have translated into interest in developing untested
managers. Perormance and pedigree still matter. So does the
maturity o the und. Only 40% o CIG: Institutional Survey
2011 respondents indicated that they would be willing to
invest at inception, and just under hal require a minimum o
one years track record to even consider investing. When the
responses are considered in the context o asset weighting,
the environment or less tested vehicles becomes more
challenging. The majority o pensions, oundations and
endowmentswho control the lions share o the assets and
make the largest placementsrequire that the managers they
allocate to have at least two years o perormance history.
Additionally, we have ound that while many investors are
willing to make placements in small or start-up unds, those
unds are likely to be managed by experienced managers and
not new entrants.
On average, most respondents said that they spent three to
six months on due diligence; nearly 20% said that they spent
6 to 12 months. The majority o respondents reported that
they increased the depth and breadth o their due diligence
rather than the requency. A clear majority increased due
diligence out o concern over operational issues. The average
number o due diligence questionnaires elded per month
by J.P. Morgans Prime Brokerage Group increased by 250%
between 2008 and 2010. Responding pensions, endowments,
oundations and wealth management companies were
signicantly more likely to spend over six months on due
diligence than other investors.
Greater tha Six Moths to Complete Due Diligece
by Ivestor Type (2010)
Source: J.P. Morgan Capital Introduction Group: Institutional Investor Survey, 2011 Figure 28
Wealth
Management
Company
30%
Family Oce
23%
Insurance
Company
20%
Consultant
18%
Fund of Funds
17%
Bank
12%
Endowment,
Foundation
and Pension
31%
Average Time to Complete Due Diligece (20072010)
Source: J.P. Morgan Capital Introduct ion Group: Institut ional Investor Survey, 2011 Figure 31
14%
22%
20102007
612 monthsGreater than 1 year
Ivestors Willig to Lock-Up or More tha Two Years
(20082010)
Source: J.P. Morgan Capital Introduction Group: Institutional Investor Survey, 2011 Figure 32
2008 2009 2010
49%46% 45%
Source: J.P. Morgan Capital Introduct ion Group: Institut ional Investor Survey, 2011 Figures 29 and 30
Miimum Track Record Required
to Make Ivestmets (2010)
Miimum Track Record Required to Make Ivestmet
by Edowmets, Foudatios ad Pesios (2010)
3 years or more 17%
2 years 19%
1 year 13%
6 months 11%
Fund Inception 40%
Greater than 2 years 63%
1 year 3%
6 months 3%
Fund Inception 31%
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Investors continue to stress the importance o liquidity.
More than hal o our respondents would not commit to a
lock-up period o over one year. Sentiment varied greatly by
segment, however. Nearly 75% o endowments, pensions and
oundations respondents indicated they would accept lock-upso over two years, while other segments were less willing to
make comparable commitments. Most responding investors
require liquidity quarterly, and only 22% require it more
requently. Liquidity requirements vary by region. Only 11% o
North American investors reported that they require monthly
liquidity, compared to 38% or Asian investors and 39% or
Europeans. More than 15% o North American investors
were willing to accept semi-annual or annual liquidity, and
20% said that they had no real preerence. In ollow-up
discussions with investors outside o North America, moreaccessed hedge unds through und o unds platorms and
had the need to manage heightened asset/liability mismatch
risk. Additionally, the allout rom the Mado scandal has
been particularly impactul on investor sentiment outside
the United States.
Required Liquidity (2010)
Source: J.P. Morgan Capital Introduction Group: Institutional Investor Survey, 2011 Figure 33
No Preference 15%
Monthly 22%
Quarterly 53%
Semi-annually 5%
Annually 5%
Logest Acceptable Lock-Up Period (2010)
Source: J.P. Morgan Capital Introduction Group: Institutional Investor Survey, 2011 Figure 34
None 6%
6 months 6%
1 year 43%
2 years 28%
3+ years 17%
Respodet Base (2010, based o umber o respodets)
Source: J.P. Morgan Capital Introduction Group: Institutional Investor Survey, 2011 Figure 35
Yes 29%
No 71%
Yes 27%
No 73%
Planning to Invest via Managed Accounts Planning to Invest via UCITS
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2011 InVESTOR SEnTIMEnT REPORT | 17
Managed accounts and UCITS structures oer investors
platorms with the potential to satisy their requirements or
increased liquidity. Interest in both, however, has been limited.
In 2009, nearly 40% o our respondents indicated that they
planned to invest in managed accounts in the coming year.Less than 20% actually did. At the end o 2009, 34% o our
respondents said that they intended to invest in UCITS in the
coming year. Only 19% did. Many o the more experienced
investors polled said that while requent liquidity was attractive,
they were concerned that constant changes in the capital base
would negatively impact perormance. Additionally, responding
investors in all regions acknowledged that these more liquid
vehicles were only suitable or specic, airly straightorwardstrategies. Another signicant impediment appears to be
structural. In all, 25 to 30% o responding investors indicated
that they were interested in making placements in these more
liquid platorms in 2011. Less than 5% o hedge und managers
indicated that they planned to launch a UCITS strategy in
2011. For und managers, the operational complexity and
increased expenses associated with these strategies make
them attractive only when they garner very substantial
placements. Many managers that we spoke with indicated
that they would consider launching a UCITS or a managed
account oering only i they could place substantially more
than $100 million into it. With 83% o our responding investorsstating they intend to invest less than $25 million in separately
managed accounts, the mismatch becomes obvious. Assets in
both managed accounts and UCITS have increased in recent
quarters; UCITS experienced a substantial one-year growth in
2010 with total assets under management increasing 198%
to $90.5 billion [Absolute UCITS]. While this surge in AUM issignicant, the total asset base remains relatively small when
compared to a total hedge und asset base o $2 trillion. While
we believe that these assets will continue to grow, we also
believe that the total allocations to these improved liquidity
vehicles will likely remain modest in comparison to the hedge
und segment as a whole.
Transparency continued to be an area o intense ocus or
investors as we entered 2011, but the degree o transparency
required diered greatly depending on investor type. Overall,
we ound that a meaningul percentage o respondents
increased their transparency requirements rom moderateto high, meaning that they required position-level detail on a
recurring basis. Only 6% o respondents surveyed stated that
they required nothing more than quarterly or monthly letters.
Among these respondents, consultants and und o unds, not
surprisingly, were signicantly more likely to require high
levels o transparency. Both, or example, reported that they
required high levels o transparency at double the rates that
wealth management companies, insurers and amily ofces
did. The majority o those that were more likely to invest
directly, or via a und o unds or consultant, reported that
they required moderate levels o transparency.
Maagers Itedig to Lauch a UCITS Strategy i 2011
Source: J.P. Morgan Consulting Group Client Benchmarking Survey Figure 36
Possibly
14%
No
81%
Yes
4%
Currently Have One
1%
Risk Trasparecy Required by Respodets (2010)
Source: J.P. Morgan Capital Introduction Group: Institutional Investor Survey, 2011 Figure 37
Limited (monthly/quarterly
letters only) 6%
Moderate (summary information
on a regular basis) 61%
High (position level detail
on a regular basis) 33%
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18 | Prime Brokerage
In conversations with investors, we consistently ound that they
viewed the lack o transparency to be a critical impedimentto growth in the hedge und segment. For many strategies
it makes sense to restrict liquidity; too much liquidity can
damage returns. But the continued lack o transparency, rom
the perspective o our investors, was something that they
ound to be less easy to accept; the technology is too widely
available. Additionally, a hedge und managers ability to deliver
a reasonable level o transparency is oten viewed by investors
as a general barometer or their overall control environment.
From discussions with individual investors, we ound that one
o the main reasons why investors are asking managers or
current and historical holdings is their concern over assets
that could be illiquid and problematic i another nancial crisiswere to occur. Overall, a third o our respondents reported that
they required high levels o transparency, but only 20% o
the managers we polled said that they provided it. We turned
to our hedge und managers to nd out more about the kinds
o transparency they were providing. The primary determinant
o high transparency appeared to be the perceived, or actual,need or the manager to provide it, in order to attract a critical
mass o institutional capital. Hal o the emerging managers
that we polled provided high levels o transparency. They
were the most willing to provide position-level data by a
substantial margin. They were also the managers with the
least assets and most were seeking to raise additional capital.
A third o mid-sized credit unds and a quarter o credit unds
managing $150 million to $500 million in assets reported
providing current holdings transparency to investors. Credit
unds can be particularly complex, and we were somewhat
surprised that so many managers provided high levels o
transparency. From discussions with managers, we knew thatmost o these unds were also seeking to raise capital as well.
Far ewer credit und managers in the Billion Dollar Club were
seeking new capital, and less than 13% o them reported that
they were providing high levels o transparency. Long/short
Risk Trasparecy Required by Ivestor Type (2010)
Source: J.P. Morgan Capital Introduction Group: Institutional Investor Survey, 2011 Figure 38
0%10%20%30%40%50%60%
70%80%90%
Moderate LimitedHigh
32%
11%
44%
58%
7%
41%
4% 7%
55%
20% 20%
73%80%
75%
44%
31%
11%18%
64%
Bank Consultant Family Oce Fundof Funds
InsuranceCompany
WealthManagement
Company
Endowment,Foundationand Pension
4%
Trasparecy Levels or Ivestor Reportig Across All Fuds
Source: J.P. Morgan Consulting Group Benchmarking Survey Figure 39
Portfolioand RiskAttributes
78%
35%
CurrentTop 10
Winners& Losers
HistoricalHoldings(1 month
prior)
22%
CurrentHoldings
19%
HistoricalHoldings
(3 monthsprior)
19%
PerformanceAttribution
73%
Most Transparent Least Transparent
Most Trasparet Reportig Optio by Fud Category: Curret Holdig Frequecy
Source: J.P. Morgan Consulting Group Client Benchmarking Survey Figure 40
50%
33%
25%
20%
13%
10%
7%
0%
29%
$0150 MM Emerging Managers
$500 MM$1 BN Credit
$5 BN+ Multi-Strategy
$150500 MM Credit
$110 BN Long/Short Equity
$1 BN+ Credit
$500 MM$1 BN Long/Short Equity
$15 BN Multi-Strategy
$150500 MM Long/Short Equity
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2011 InVESTOR SEnTIMEnT REPORT | 19
equity managers are probably the ones whose strategies most
lend themselves to transparency, yet 80% o these managers
with between $1 billion to $10 billion in capital did not provide
investors inormation on current holdings.
When we looked at the type o inormation that managers
were providing, we ound that nearly two-thirds gave
investors perormance attribution reporting and nearly 80%
published portolio and risk analytics. These types o reports
are challenging to produce in a timely and accurate manner
when acing o against multiple prime brokers. We saw the
high incidence o report provision in these two areas as
consistent with a trend that we had identied in previous years,
namely that hedge und managers were increasingly investing
in middle ofce technology in order to complete the value
chain between their portolio managers and traders. Less than
a third o managers we surveyed were providing other typeso inormation, such as historical holdings or winning and
losing positions.
We ound one additional response to be particularly striking.
In 2010, 24% o CIG: Institutional Survey 2011 respondents
indicated that they purchased a tail risk product. This suggests
that nearly a quarter o institutional investors bought in to
an investment strategy that barely existed three years ago.
Moreover, 35% o our respondents indicated that they expect
to invest in a tail risk product in 2011. The hedge und segment
may be poised or a period o sustainable growth, but investors,it appears, will be looking over their shoulders or some time
to come.
Respodets Ivested i a Tail Risk Product (20102011P)
Source: J.P. Morgan Capital Introduction Group: Institutional Investor Survey, 2011 Figure 41
2011P2010
35%
24%
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Institutions have begun to change the nature o the larger
relationships that hedge und managers have with their
investors in important ways, reecting a shit in the relative
power held on either side o the capital equation, but one
that has been unevenly realized. Over the course o the
past two years, the majority o institutions have successully
renegotiated some portion o their agreements with at least
one o their hedge und managers. This has been particularly
true o investors that make large placements. However, as the
great reallocation played out over the course o 2010, capital
shited to the largest hedge und managers with the most
attractive perormance characteristics. These managers have
proven to be much less likely to make signicant changes in
order to accommodate investors. Our 2009 and 2010 studies
depict an industry in ux. We believe that increasing inuence
o the largest institutional investors will continue to drive
change through 2011, but they will come up against some
immovable objects in the orm o very large hedge unds that
have no shortage o investor interest.
In 2010, 37% o responding investors reported that they
renegotiated management ees and 25% said that they
renegotiated perormance ees. Overall, 87% indicated
that they redeemed rom a hedge und. We think that two
things stand out about these responses. First, nearly hal
o our responding investors making average placements
o between $25 million to $100 million were successulin renegotiating core terms with at least one o their
hedge und managers. Only 21% o responding investors
whose average placements were between $1 million to
$5 million were able to win similar concessions. In ollow-up
conversations with these investors, we ound that most used
a period o subpar, but not poor, relative perormance as an
opportunity to reprice the relationship. They extracted other
concessions as well, such as reduced lock-ups and improved
liquidity. Smaller investors were not nearly as successul in
convincing even underperorming managers to move in their
direction on terms. The second aspect o these responses that
we elt signicant was that the leading reasons or redemptions
were related to poor or erratic perormance. In 2010, as in 2009,
the overwhelming majority o respondents redeemed because
their hedge und investment underperormed. Another leading
reason was style drit, which was also perormance related.
Considerably urther down the list were liquidity-related
issues, but these only became material when the manager was
underperorming and the investor was trying to exit. Issues like
lack o transparency and inadequate communication were down
the list as well. Investors wanted liquidity, transparency and
controls. But they wanted perormance even more. We ound
that the largest investors have been successul in convincing
many hedge und managers to provide improvements in these
areas, but the change was concentrated amongst the ranks
o the smaller and/or underperorming managers.
Respodets Who Reegotiated the Maagemet Fee
with Hedge Fud Maagers (2010)
Source: J.P. Morgan Capital Introduction Group: Institutional Investor Survey, 2011 Figures 43 and 44
Respodets Who Reegotiated the Perormace Fee
with Hedge Fud Maagers (2010)
Yes 37%
No 63%
Yes 25%
No 75%
IV. Balance o Power
Respodets Who Redeemed rom a Hedge Fud (2010)
No 13%
Yes 87%
Source: J.P. Morgan Capital Introduction Group: Institutional Investor Survey, 2011 Figure 42
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2011 InVESTOR SEnTIMEnT REPORT | 21
One o the signicant impacts o reallocation in 2010 is that
the relative strength o the largest hedge und managers
increased. Industry statistics showing increased concentration
are clear, and we ound similar results in our polling data. In
all, 48% o hedge unds managing over $1 billion in assetsthat we surveyed stated that they added unds in 2010; only
8% said that they subtracted unds. Many o these large
managers also opened existing vehicles to new investors.
More than 85% o these hedge und executives indicated that
their management ees were still above 1%; over hal charged
2% or more. Perormance ees remained in the 20% range
or roughly 85% o these same managers, and 7% charged
even more. As we discussed earlier, most o the largest hedge
unds have done little to increase transparency and liquidity.
It does appear, however, that they made signicant eorts to
improve controls. More than 80% o hedge unds managing
$1 billion or more in assets that we surveyed indicated that
they employ a chie compliance ofcer. More than 95% o
these managers said that they had either already registered
with the SEC or are planning to register. Most will argue that
there is room or improvement, but most also say that they
have seen real progress. Improving the control environment
requires real investment on the part o hedge und managers.
However, it also delivers real benets in a market where
managers oten run multiple strategies in multiple regions
and ace o against multiple prime brokers. Which brings
us back to the core issue: by rotating so much capital into
the largest hedge unds, investors have bought into hedge
unds with superb track records, but they have also shited
the balance o power in many core relationships over to
the manager.
Hedge Fuds Addig or Subtractig Fuds i 2010
Source: J.P. Morgan Consulting Group Client Benchmarking Survey Figure 45
Neither
65%
45%
Subtracted Funds
8% 11%
Added Funds
47%
24%
$1 BN
Hedge Fud Perormace Fee Structure (2010)
Source: J.P. Morgan Consulting Group Client Benchmarking Survey Figure 46
Other
12%7%
20%
85% 82%
Less than 20%
8% 7%
$1 BN
$1 Billio+ Hedge Fud Maagemet Fee Structure (2010)
Source: J.P. Morgan Consulting Group Client Benchmarking Survey Figure 47
Other
16%
2.0%
38%
1.5%
34%
1.0%
9%
0.5%
3%
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When looking to 2011, CIG: Institutional Survey 2011
respondents said that they expect three types o trends to
develop. The rst are changes that investors themselves
expect to drive. In all, 79% o our respondents expect to see
increased transparency in the coming year, with 58% predicting
more due diligence on investors in a und. Institutions were
sanguine about their ability to cause signicant change to the
terms o their broader relationships with hedge unds, but
primarily with the smaller ones. Over 90% stated that they
did not see longer lock-ups as likely to happen, and 53%
expected ees to decrease. However, investors were
demonstrably unsuccessul in extracting term and ee changes
rom the large, top perorming hedge unds where they were
allocating the overwhelming majority o capital. Moreover,
in ollow-up conversations with responding investors, we ound
that they seemed to be happy to pay or perormance and make
concessions on terms i the manager actually delivered. Overall,
our respondents conrmed that they elt they could rebalance
the terms o their relationships with hedge unds, but only
where the managers were new, small or underperorming.
Responding investors also expect to see changes that come
about as indirect eects o their actions. More than hal
said that they expect to see increased consolidation in
the hedge und segment. Nearly 70% o our respondents
anticipate hedge und leverage to increase or stay at current
levels. Throughout much o 2010, hedge und indexes were
highly correlated with major equity market indexes. We
believed then that investors seeking superior risk-adjusted
returns and diversication would, at some point, begin to
pressure their managers to act with more conviction. That
appears to be happening now, and we believe that theconcomitant uptick in the leverage o J.P. Morgans Prime
Brokerage clients is a good indicator.
The nal type o change that responding investors think will
be seen in 2011 is regulatory. Overall, 86% o our respondents
said that they expect increased regulation over hedge
unds. Investors that we spoke with separately on this topic
indicated that regulatory changes were likely to be generally
complementary to the trends that investors hoped to drive.
They also stated that they have little ability to predict what
these changes may be at any detailed level.
Hedge Fud Treds or 2011
Source: J.P. Morgan Capital Introduction Group: Institutional Investor Survey, 2011 Figure 48
86%
79%
53%
52%
37%
31%
26%
7%
58%
Increased Regulation
Increased Transparency
More Due Diligence on Investors in a Fund
Lower Fees
Consolidation
More Money Allocated to Managed Accounts
Decreased Leverage
More Money Allocated to UCITS
Longer Lock-Ups
0% 20% 40% 60% 80% 100%
V. Looking Ahead
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2011 InVESTOR SEnTIMEnT REPORT | 23
This years research was conducted over the course o the
ourth quarter o 2010 and rst quarter o 2011. When
constructing the respondent universe, we ocused on investor
quality and demographics (i.e., investor type, location and
years o experience). Our goal was to acilitate the assembly
o a orum or a balanced group o thought leaders. We
were ortunate to be able to involve many o the worlds
leading institutions in this eort. At the time o the survey,
the respondents had placed $0.7 trillion into the hedge und
segment. The respondents were geographically diverse, with
24% coming rom Europe, 17% rom Asia and 56% rom
Canada and the United States. Geographic segmentation
proved to be important in evaluating the surveys results, as
investors in dierent regions expressed divergent views on a
number o important topics.
Survey participants also represent a mix o levels o experience
in, and exposure to, hedge und investing. In all, 88% o
respondent assets invested in hedge unds were controlled by
investors who reported at least seven years o experience in
the space. We included a signicant number o investors who
were newer to hedge unds. These respondents were identied
using the same quality and demographic screens as the more
experienced investors who had placed the lions share o the
capital into hedge unds at the time o the survey.
The perspectives o the newcomers proved to be important,
as they represent the largest source o potential capital
inows and oten had views that diered rom those o
more experienced responding investors on several important
points. Approximately 40% o respondents disclosed they had
more than $1 billion invested in hedge unds at the time o
the survey. The remaining 60% consists o investors rom a
broad spectrum o placement sizes and includes responses
rom several high quality investors with very little, but high
potential, exposure to hedge unds.
Respodet Base (2010, based o umber o respodets)
Source: J.P. Morgan Capital Introduct ion Group: Institut ional Investor Survey, 2011 Figure 50
Middle East andLatin America 3%
Asia 17%
Europe 24%
North America 56%
Insurance Co. 3%
Consultant 5%
Other 6%
Wealth Mgmt. 6%
Bank 7%
Endowment, Foundation
and Pension 10%
Family Oce 19%
Fund of Funds 44%
Geographic LocationInvestor Types
Hedge Fud Ivestig Experiece
(2010, based o AUM i Hedge Fuds)
Source: J.P. Morgan Capital Introduction Group: Institutional Investor Survey, 2011 Figure 49
Less than 1 year 1%
13 years 9%
46 years 17%
710 years 22%
Greater than 10 years 51%
Overview o the J.P. Morgan CIG: Institutional Investor Survey, 2011
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IMPORTANT DISCLAIMER
These materials (Materials) have been prepared by J.P. Morgans Prime Brokerage business (JPM PB) or inormational purposes only. No research department within J.P. Morgan Chase & Co.
was involved in the preparation o or data collected or these Materials. Primarily, these Materials are intended to serve as JPM PBs analysis o survey responses collec ted by J.P. Morgans PrimeServices Capital Introduction Group (CIG) rom institutional hedge und investors that par ticipate in J.P. Morgans Prime Services Capital Introduction Program (the CIG Program). The number o
institutional hedge und investors represented in thes e Materials is smaller relative to the size o the institutional hedge und investor marketplace, and these Materials are not intended to represent
the views o the institutional hedge und investor community at large. Although these Materials are derived rom sources believed to be reliable, these Materials have not been veriied or accuracy
or completeness by J.P. Morgan Chase & Co. or by any o its subsidiaries, their respective ailiates, successors, assigns, agents , or by any o their respective oicers, directors, employees, a gents or
advisers (collectively, J.P. Morgan), and J.P. Morgan does not guaranty the se Materials in any respect, including but not limited to, their accuracy, completeness or timeliness. Inormation or these
Materials was collected and compiled during the s tated timerame. J.P. Morgan has no obligation to update any portion o t hese Materials. Past perormance is n ot a guarantee o uture results.
These Materials may not be relied upon as deinitive, and shall not orm the basis o any decisions contemplated thereby. It is the users responsibility to independently conirm the inormation
presented in these Materials, and to obtain any other inormation deemed relevant to any decision made in connection with the subject matter contained in these Materials. J.P. Morgan makes no
representations (and to the extent permitted by law, all implied warranties and representations are hereby excluded), and J.P. Morgan takes no responsibility or the inormation presented in these
Materials. These Materials are provided or the intended users use only, and no portion o these Materials may be reproduced or distributed or any purpose wit hout the express written permission
o J.P. Morgan. None o the inormation presented in these Materials shall constitute, or be construed as constituting or be deemed to constitute an o er to buy or sell or a solicitation o an oer
to buy or sell any securities.
The CIG Program operates through J.P. Morgan Clearing Corp., J.P. Morgan Securities Ltd, J.P. Morgan Markets Limited, J.P. Morgan Chase Bank N.A., Singapore Branch (JPMSB), J.P. Morgan
Securities (Asia Paciic) Limited (JPMSAPL) and J.P. Morgan Securities Japan Co., Ltd. (JPMSJ). J.P. Morgan does not charge or receive ees or introduc tion services provided t hrough the CIG
Program. The CIG Program does not provide capital raising, placement agent, reerral, solicitation or equivalent services (Placement Services) to unds, their related investment managers,
general partners, managing members or their equivalent s that participate in the CIG Program (Manager Participants). The CIG Program also does not provide investment recommendations or
endorsements o any kind (Advisory Services) to eligible prospective institutional investors participating in the CIG Program (Investor Participants), including in relation to Manager Participants,
recommendations or endorsements o their services, products, investments or investment strategies. Placement Services and Advisory Services may, however, be provided by J.P. Morganbusinesses unrelated to the CIG Program. Inormation presented in connection with the CIG Program may not be suitable or any and all institutions. Under all applicable laws, including but not
limited to, the U.S. Employee Retirement Income Security Act o 1974, as amended, or the U.S. Internal Revenue Code o 1986, none o the inormation presented in connection with th e CIG Program
shall constitute, or be construed as cons tituting or be deemed to constitute investment advice, and J.P. Morgan is not acting as iduciary or any purpose.
An investment in a hedge und is speculative and involves a high degree o risk, which each investor must careully consider. Returns generated rom an investment in a hedge und may not
adequately compensate investors or the business and inancial risks assumed. An investor in hedge unds could lose all or a substantial amount o his or her investment . While hedge unds are
subject to market risks common to other types o investments, including market volatility, hedge unds employ certain trading techniques, such as the use o leveraging and other speculative
investment practices that may increase the risk o investment loss. Other risks a ssociated with hedge und investments include, but are not limited to, the act that hedge unds: can be highly illiquid;
are not required to provide periodic pricing or valuation inormation to investors; may involve complex t ax structures and delays in distributing important tax inormation; are not subject to the
same regulatory requirements as mutual unds; oten charge higher ees and the high ees may oset the unds trading proits; may have a limited operating history; can have perormance that
is volatile; may have a und manager who has total trading authority over the und and t he use o a single adviser applying generally similar trading programs could mean a lack o diversiication,
and consequentially, higher risk; may not have a secondary market or an investors interest in t he und and none may be expec ted to develop; may have restrictions on trans erring interests in the
und; and may aect a substantial port ion o its trades on oreign exchanges.
2011 JPMorgan Chase & Co. All rights reserved. J.P. Morgan is a marketing name or the prime brokerage business o JP Morgan Chase & Co. and its subsidiaries worldwide. Clearing and custody
services are provided by J.P. Morgan Clearing Corp. (JPMCC) and J.P. Morgan Securities Ltd (JPMSL). Access to inancial product s and execution ser vices is oered through J.P. Morgan Securities
LLC (JPMS). JPMCC and JPMS are each separately registered broker dealer ailiates o JP M organ Chase & Co., and are each members o FINRA, NYSE and SIPC. JPMSL and J.P. Morgan Markets
Limited are authorized and regulated by the FSA. JPMSAPL is licensed and regulated by the Securities and Futures Commission o Hong Kong. JPMSB is regulated by the Monetary Authority o
Singapore. JPMSJ is registered and regulated by the Financial Services Authority in Japan. All o the oregoing entities are subsidiaries or ailiates o JPMorgan Chase & Co. and are included in the
JPMorgan amily o companies. Product names, company names, and logos mentioned herein are trademarks or registered trademarks o their respective owners.
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