Changes seen as a constant for 2009

Credit strategies are in; hedge funds and 130/30 funds are out.

A recent survey by money manager consultant Eager Davis & Holmes LLC showed that investment consultants expect U.S. institutional investors to be actively re-balancing or making strategic adjustments to investment portfolios this year. As a result, managers who haven’t met expectations may get the boot, the survey found.

As part of those adjustments in 2009, opportunistic strategies will trump the quantitative strategies that were favored last year and in 2007.

FOUR THEMES

David Eager and Glenn Davis, partners at the Louisville, Ky., firm, identified four themes for 2009: re-balancing, replacing, rethinking and responding.

“A lot of money is going to be moving around in 2009,” Mr. Eager said in an interview. “The first half of the year, there will be a lot of reflecting and challenging of investment assumptions, but all evidence points to a very active second half of the year.”

The online survey — of 74 institutional investment consultants from 46 consulting firms — took place in late December and early January. The 46 firms had more than $10 trillion in combined assets under advisement.

Of the consultants surveyed, 77% predicted that a lot of U.S. institutional investor clients would be re-balancing, and 42% predicted that investors would make long-term strategic adjustments to their investment portfolios and replace managers who weren’t meeting expectations. Another 32% predicted that clients would make investments that took advantage of opportunities created by the market crisis.

The consultants expect increased demand for liability-driven investing (53%), global mandates (45%), absolute-return strategies (41%) and tactical-asset-allocation/multiasset portfolios (39%).

When asked in which opportunistic areas they expected to see a lot of activity, consultants said that distressed debt (48%), high-yield fixed income (46%) and bank loans (32%) would see the most interest.

As for decreased demand among investment products and strategies, the consultants predicted lower interest in single-manager hedge funds (78%), 130/30 equity strategies (70%), quantitative equity (62%), hedge funds of funds (52%) and private equity (31%). The consultants were relatively neutral about U.S. equity and core/core-plus fixed-income strategies.

Scandals such as Bernard Madoff’s alleged Ponzi scheme, which may have defrauded investors of $50 billion, are a factor in the decreased demand for hedge funds, Mr. Eager said.

But performance is also key.

“Some fell way short of expectations,” Mr. Eager said. “The expectation was that they would provide protection in bad markets; [the funds] didn’t get it in some cases.”

In order to respond to the shifts in thinking among institutional investors, money managers need to “stay close to their clients” and keep up conversations.

Mr. Eager called 2008 “a year of extreme market activity.” This year “is going to need to be the year managers focus on client communication,” he said.

The consultants surveyed said that managers should expect the most scrutiny from institutional investors in the areas of understanding portfolio risk controls (85%), stability and continuity of investment staff (81%), and financial wherewithal and stability of the managers (76%).

The survey also indicated that fund sponsors are likely to adopt portfolios that limit the impact of shorter-term market gyrations on balance sheets and funded status, and that domestic-equity products that don’t have rigid style box constraints will be more popular.

Jennifer Byrd is a reporter for sister publication Pensions & Investments.