Institutional investors are taking greater interest in how hedge funds manage risk, operational infrastructure and the way they generate returns when considering new managers, according to State Street's latest Vision report.
The research, which examines the re-emergence of the hedge fund industry, said the days of "no questions asked performance are gone" and unlikely to return.
It said the post crisis environment of fund selection would emphasise six key operational risk management elements: investment strategy and performance, liquidity, transparency, reconsideration of pricing and lock-up periods, operational due diligence and the independence of custodians and administrators.
"Institutional investors, once preoccupied largely with fund performance, now take great interest in the manner by which funds manage operational infrastructure, choose administrators and provide for governance and best practices," State Street alternative investment solutions group head George Sullivan said.
"Asset owners today want to know how returns were achieved, the strategies that drive them and the risks encountered at every stage of the investment process
"In this flight to quality, investors have made it clear that front-to-back-office integration and the administrators' reputation, capabilities and service orientation carry substantial weight in their consideration of any new fund manager."
Sullivan said the escalating client demand for operational control and transparency was driving hedge funds to outsource many responsibilities to administrators that were experienced in all asset types and investment strategies.
"By hiring administrators to assume a range of services, including data management, asset class coverage and portfolio risk analysis, fund managers can concentrate on generating alpha and distributing investment products," he said.
The report comes amid expectations of a bigger take-up in alternatives investing by large investors.
According to the Russell Investments 2010 Global Alternative Investment Survey, which included pension funds, endowment, foundation and insurance investors in Australia, North America, Europe and Japan, participants reported they planned to boost their allocation to alternatives to 19 per cent by 2012 from 14 per cent.
The hedge fund industry's assets under management crossed US$2 trillion for the first time in the first quarter of 2011, surpassing the previous record of US$1.93 trillion in 2008, Hedge Fund Research said.
