Each quarter, BHA analysts collect detailed profiles from more than 1,300 investors that are actively making investments in hedge funds, private equity and real estate funds, and related funds of funds. These investors are spread across the globe; their assets under management (AUM) range from less than $100 million to more than $10 billion dedicated to alternative investments.

Analysts speak with investors about their current preferences regarding alternative strategies, manager requirements, investment processes, due diligence systems, future allocation plans, and current and historical areas of exposure. The team then conducts both quantitative and qualitative analysis of the data to explore trends within the alternative investment marketplace. These trends reveal shifts in investor sentiment about alternative investments and provide unprecedented insight into the mindset of alternative investors during the past quarter. Analysts then explain these trends in the BHA Quarterly Research Report.

The latest BHA Quarterly Research Report will be released this week. During the fourth quarter, analysts tracked significant interest among hedge fund investors for global macro funds. Analysts also noted that natural resources were a consistent sector interest. Private equity fund investors focused a significant amount of attention on funds that were taking advantage of opportunities in the secondary space. Interest in funds of hedge funds started to recover among family offices, especially funds that were focused on commodities. Real estate funds also benefited from a market rebound especially in the U.S. and Europe where investors were interested in sourcing fund opportunities in commercial real estate. Early indications for 2010 are that the loosening of credit is finally beginning to have a significant impact on the alternative investment community as capital is beginning to flow back into the industry following the redemptions sparked by th e crisis in 2008.

There is a general undercurrent of optimism among investors as the world’s emerging markets take the lead in the global economic recovery.

During the past month, the analyst team at BHA interviewed 43 firms that were actively looking to hear from alternative fund managers focused on emerging markets. Nearly half of that interest was in China-focused funds.

Prior to 2008, China was spurring global economic growth that was consistently in the double digits. Today, the country is once again at the forefront, but its economy is not the only one that is expected to expand during the next several quarters. The director of investments at a Midwestern wealth advisory firm told BHA that in addition to China, his firm is focusing on investment opportunities in Brazil, India, and Russia as a result of the anticipated growth in those regions. In addition to Brazil, some private equity and hedge fund investors cited other South American countries as of significant interest.

Analysts at BHA also have seen a significant increase in the number of investors interested in CTA funds, with over 200 expressing interest during the fourth quarter alone. As emerging markets resume expansion and growth, so, too, will they resume consumption of natural resources and commodities, driving prices higher.

The head of due diligence at a New York family office stressed that the firm is interested in any funds that are uniquely situated to make directional bets on the commodities and natural resources sectors heading into the first quarter.

As the global economy begins to recover, investors seem keen to be on board. Funds focused on emerging markets and commodities and natural resources are the investments of choice heading into 2010.

Short-bias fund managers are enjoying a renewed surge in investor interest following a lengthy stretch during which economic optimism and performance made the strategy decline in popularity.

According to Hedge Fund Research, the HFRX Short Bias Index is down nearly 20 percent for the year, but it was the best performing index over the past month: it was up nearly 4 percent. Sustained outperformance in world markets, coupled with an overall optimism among investors, has pushed up major world equity indexes during the past ten months. However, as more and more difficult economic data persist in GDP growth rates and unemployment numbers, it appears that short-bias managers may be uniquely situated to benefit from a market correction that reveals the instability and problems that continue to disrupt world economies.

During the past few weeks, several institutional and retail investors have expressed an interest in short-bias fund strategies as a hedge in the event that the current bull run is short lived and unsubstantiated. The CEO of a fund of hedge funds located in the Western United States is currently searching for excellent short-bias managers that were able to outperform in 2008 and preserve capital in 2009.
The HFRX Short Bias Index’s performance provides evidence for why many investors have begun to search for funds that are directionally positioned to protect against any downturn in the markets. Brighton House analysts will continue to monitor this trend closely in the coming quarters to ascertain if fund managers and investors that are fearful of an economic pullback will be proved justified.

In a recent article entitled “What Investors Want from Hedge Funds Now,” Standard & Poor’s argues that investors have begun to look at hedge funds in a new way. 2008 fundamentally altered the hedge fund business, and according to S&P, uncorrelated returns that outpace the market’s performance are no longer investors’ main focus.

This trend has continued to surface in the research that BHA has been conducting during the past several quarters. In interviews with investors of every size and in every category, BHA consistently finds that outsized returns are not investors’ main concern when selecting a hedge fund manager.

Of the investors BHA analysts interviewed during the past two months, 83 percent stressed that they were interested in funds that were offering quarterly liquidity or better. Interestingly, BHA data also suggests that more than 62 percent of investors interviewed during that same period are comfortable with a fund imposing a lock-up. This could indicate that investors are placing greater emphasis on building stronger and longer-lasting relationships with fund managers that are willing to offer more transparency and foster trusting partnerships.

The S&P article also indicated that investors are avoiding highly leveraged funds because, currently, leverage is seen as an unnecessary investment tool that needlessly increases risk. In a recent interview with a senior research analyst at a U.S. fund of hedge funds, BHA discovered that the firm was not considering any funds that were using more than 3x leverage to drive returns. The fund of funds does not believe the potential returns are worth the added risk of excess leverage.

It appears that while absolute returns used to be the driving force behind hedge fund investments, the paradigm has shifted. Funds that offer transparency, increased risk controls, and better liquidity terms are more attractive to investors as they begin to return to hedge funds with new expectations and new criteria for investment.

As hedge funds recover from the economic crisis and fraud that plagued the industry in 2008, investors are moving back into alternative funds-and requiring more than just uncorrelated returns. Many are demanding funds have institutional quality infrastructures, independent auditors, and significant asset bases to weather highly volatile markets. Endowments, foundations, and pension plans, in particular, are demanding an increasingly sophisticated and professional hedge fund operational structure be in place before they are willing to risk investment.

At BHA, we have spoken with several institutional investors that have indicated one of the most important criteria for their investment committees to consider is the infrastructure that supports the fund. Institutional quality infrastructure can be defined in many ways. It can cover everything from a manager’s back office operations, fund structure, and organization to its independent oversight procedures and valuations.

Institutional investors are also seeking funds with large asset bases managed by experienced financial professionals that have defined positions and roles in the firm, strong pedigrees in the industry, and verifiable track records. Many investors perceive such funds as a more stable investment option and not as susceptible to collapse if negatively impacted by directional bets or redemptions. During the month of August, 57 percent of the hedge fund investors BHA interviewed were only interested in fund managers that had $100 million to $1 billion under management. And in a recent conversation, the head of hedge fund research at a North American consultant said that the firm was considering only funds with more than $1 billion in assets and a ten-year track record.

Investors perceive that funds with large asset bases and long track records have the experience and institutional infrastructure to handle volatile market events. And given the times, investors are in a position to be more selective and demanding. Managers that incorporate this level of sophistication into the administration of their funds will help allay investor concern over instability and outflows.

In the past four weeks, investors have increasingly mentioned an interest in high-velocity, short-term trading quantitative managers. Wealth advisors, funds of hedge funds, and consultants are all interested in interviewing algorithm-based managers to see if they can give investors a competitive edge as the global markets begin to ease their downward spiral.

Black box funds, which fell out of favor during 2008 for breaking down in the face of a catastrophic market collapse, are well positioned to evaluate the subtle economic indicators of a potential recovery before it is widely discovered. These high-velocity trading strategies are also highly liquid, and this continues to help drive interest.

An analyst at a midsize family office in London mentioned that his firm is currently turning to quantitative funds with the hope that the financial indicators that signal an economic recovery will trigger these funds to make correct directional bets and earn substantial profits. Timing is everything in a market recovery, and investors are betting that complex algorithms can predict an upturn ahead of fundamental analysis, which takes far more time.

Whether black box funds will be the first to position themselves for a recovery remains to be seen. However, BHA will continue to monitor this trend throughout the remainder of 2009.