NEW YORK Pension funds will likely funnel more money into hedge funds and become a powerful engine of growth for the industry in the coming months, a hedge fund industry veteran said on Wednesday.
"We are finding that corporate pension funds are looking at hedge funds for allocations for their equity exposures, said Carrie McCabe, chief executive of Lasair Capital LLC, a firm that creates portfolios of hedge funds for clients.
McCabe, who cemented her reputation in the hedge fund industry while running Blackstone Alternative Asset Management and FRM Americas, described a real urgency to pension funds' desire to beef up their returns with hedge funds in a hurry.
At the end of 2008, industry data showed that the largest U.S. corporate plans are underfunded by about 70 percent.
"Because pension funds have long-dated liabilities they simply can't afford to put all of their money into long equities," McCabe said at the Reuters Private Equity and Hedge Funds Summit.
Hedge funds unlike mutual funds can bet that stock prices will fall, employing a trading technique that has helped them outperform traditional portfolios for years.
Last year when the average hedge fund lost 19 percent to deliver the industry's worst-ever returns, U.S. stocks lost about twice as much.
For years, wealthy individuals fueled hedge fund industry growth by adding new money so fast that assets doubled to roughly $2 trillion between 2005 and 2008.
Pension funds which manage money for teachers, bus drivers and auto workers took a slower approach to hedge funds.
That is changing now, McCabe said.
She said the $1.4 trillion hedge fund industry could shrink to about $1 trillion at the end of the year as more individuals pull out, which means that pension funds will soon be the industry's biggest investors.
"By the end of this year, 80 percent of hedge fund money will be institutional money," she said, noting that wealthy Europeans, in particular, are pulling out of hedge funds after financial swindler Bernard Madoff spooked them.
Right now institutional investors contribute about half of the hedge fund industry's assets, industry analysts have said. Pension funds make up the bulk of institutional money.
Because institutions will play a bigger role in the industry, they will help reshape what the industry looks like.
"These investors will want to see high water marks," she said referring to a practice where managers can collect their performance fees only if the value of the invested money is bigger than its previous greatest value.
She also said investors will want to see that managers' interests are aligned with investors' interests, that fund firms have good risk management and are receptive to clients' needs. "Institutions will be focused on the robustness of a firm and make sure that their performance will last and wasn't just luck," she said.
(Reporting by Svea Herbst-Bayliss; editing by Carol Bishopric)