Equity markets have rebounded in 2009. However, investors still weary from last year’s dismal performance are looking favorably upon alternative investments to diversify their holdings. Although certainly not their best year, alternative investments have played a critical role in investors’ portfolios and been credited with helping to quell further losses. Recognizing the importance of alternative investments, many institutional pension plans are in the midst of completing asset liability and asset allocation studies either internally or with the assistance of investment consultants.

One southern U.S. employee’s retirement system has just implemented significant changes in its asset allocation with the help of a consultant. Over a three-year period, the $1.6 billion fund is moving forward with a plan to increase its absolute return portfolio from 8 percent to 12 percent, its private equity commitments from 7 percent to 8 percent, and its real estate investments from 8 percent to 12 percent. The increases come on the heels of a 10 percent reduction in domestic equity exposure. An investment analyst at the fund expressed extreme optimism in the recently approved allocation mix and expects the new targets to add substantial value and diversity to the portfolio.

A $1 billion West Coast government pension plan is following suit, recently approving a 4 percent raise each to hedge funds and private equity. Although it has historically received its hedge fund exposure through multi-manager products, the fund may consider direct investments, which will eliminate the extra layer of management and performance fees. Finally, a multi-billion dollar state treasurer’s office has implemented a 2.5 percent bump in its hedge fund exposure. The CIO was very pleased with the results of its asset allocation study and mentioned that the increase is likely to be distributed to existing managers.

The expanding allocation levels from government pension plans represent a tremendous opportunity for fund managers. Not only are such allocations usually “sticky money,” but they traditionally have eight-figure subscription amounts as well. Despite a tumultuous 2008, alternative investments may be called upon to play an even larger role in protecting these enormous pension plans from further downturns.

As reported in the July 23, 2009, issue of Brighton House Associates Investor Monitor, BHA analysts noticed a spike in investor interest in real estate funds in mid-July. During the past week, analysts have identified a considerable amount of new interest, specifically towards real estate funds within the European investor community. Institutional and private investors alike are significantly increasing their exposure to real estate, with some raising their allocation targets from 5 percent last year to more than 20 percent currently.

Investors are searching for ways to lower risk and gain more stability in their portfolios—mainly to hedge against fluctuations in equity markets. Real estate, as indicated by European investor interest, seems to be an appropriate approach.

A wealth advisor based in Finland is currently evaluating value-add investments from European commercial property funds. The firm is focused on commercial property due to the wealth of opportunities that the economic crisis has generated. The firm invests primarily in European-focused funds, as well as a few funds focused on Asia or Russia. It will begin evaluating and investing in U.S. property funds throughout the next year.

A consultant based in Denmark is researching real estate funds to present to its pension fund clients toward the start of the fourth quarter. For some of these clients, it is their

first venture into real estate; it is a new focus after completing an internal review of their asset allocations during the past few quarters. The consufirm is focused on opportunities from all real estate investment strategies. It is beginning to look at real estate funds worldwide now that pension funds want to add globally diversified products.

As reported by Thao Hua on Pensions and Investments' Web site, "…some European institutions are increasing their real estate investments. Among the investors diversifying and/or raising their allocations are the £34 billion ($55 billion) BT Pension Scheme, France's €7 billion ($10 billion) French Public Service Additional Pension Scheme, Denmark's e6.2 billion Doctors' Pension Fund, the 24 billion Danish kroner ($4.5 billion) Danish Pension Fund for Engineers, Britain's £1.8 billion Avon Pension Fund and the £550 million London Borough of Islington Pension Fund." (For article click here).

BHA analysts continue to see a significant increase in interest in real estate funds from their network of European investors and expect the trend will carry on through the fall.

Carbon cap trading, also known as emissions trading, has been gaining popularity with investors during recent quarters. Carbon cap trading has emerged in the marketplace as a flexible mechanism of the Kyoto Protocol. The protocol is a 1997 international treaty that caps the emissions of six major greenhouse gases among the most developed nations.

Institutional investors have two main reasons for wanting exposure to the carbon markets. One is to effectively hedge an environmentally damaging portion of their portfolios. Environmentally damaging sectors include industries such as oil and coal. Another reason is because the growth of the carbon markets has been eye-catching. According to World Bank estimates, the size of the carbon markets have increased five fold since 2005. In dollars, the carbon markets stand at more than $60 billion as of 2007.

These figures are compelling to institutional investors, and the demand for carbon-related funds has accelerated.

In a recent conversation with a BHA analyst, the principal of a New York-based fund of hedge funds expressed interest in researching funds that have experience navigating the natural resources and clean technology sectors. Carbon traders in particular were of interest to this investor. He believes that the $500 billion of the $2.7 trillion global stimulus package, that has been ear-marked for clean conscious energy will create immense opportunities for these types of funds. He indicated a preference for funds that trade with low-to-moderate volatility and have returns in the low teens.