Investing in alternatives to surge worldwide (Russell.com)

Russell Survey: Investing in Alternatives to Surge Worldwide
Institutional Investors in North America Double Commitment to Hedge Funds

TACOMA, Wash. — September 12, 2005 — Institutional investor commitment to alternative investments is poised to reach record levels by 2007, according to the seventh global report on alternative investing released today by Russell Investment Group. Investments in hedge funds, private equity and real estate are all forecast to rise; survey results show hedge fund use continues to increase most dramatically across all regions, and, in North America, the commitment to hedge funds has doubled, as represented by their growing share of overall allocations to alternative investments.

Since 1992, Russell has surveyed the largest tax-exempt institutions (public and corporate pension funds, endowments and foundations generally with assets of $1 billion or more) in the United States, Canada, Europe, Japan and Australia to gauge their participation in and expectations for alternative investing. The results are published in a detailed report, 2005-2006 Russell Investment Group Survey on Alternative Investing, which presents data by region, investment category and type of institution; and includes detailed analysis of strategies/investment type used, geographic allocation, and expected returns.

Topline findings from this year's study include:

Average strategic allocations to hedge funds, private equity and real estate are expected to rise to new highs by 2007.
Institutional investors across all geographic regions expect to raise the percentage of their total investment portfolio allocated to alternatives.
The number of institutional investors using alternative investments climbed in 2005, particularly due to significant increases in Europe, Australia and Japan.
Hedge funds have led much of the surge in alternatives, as a growing number of institutional investors use this investment and dedicate an ever-larger amount of money to this category. Hedge fund use continues to increase dramatically across all regions, particularly outside North America.
Return expectations are strongest for private equity, as the surveyed institutions across all regions are forecasting over 10% for this investment category. In contrast, institutional investors in North America and Europe have slightly lowered their forecasts for hedge fund returns even as they add more of these investments to their portfolios.

"This year's survey paints a clear picture — alternative investing will continue to grow at a strong pace worldwide, hedge funds will continue to garner the greatest share of increased commitments, and the smaller markets will increase their alternative investments significantly compared to more mature markets," said Tom Hanly, chief investment officer, Russell Investment Group. "Real estate, private equity and hedge funds require a skill set and mindset different from the more traditional equity and fixed-income investing, and institutional investors have become increasingly comfortable with these demands."

Following are more details from the survey:

1. Compared to 2003, hedge funds have captured a growing share of allocations to alternatives across most regions, particularly in Australia, where they now account for 13%, up from 1% in 2003. In North America and Europe, hedge funds now account for 10% of the overall allocation to alternatives, roughly double the 6% and 5% levels found in 2003 respectively.

"Still mindful of the precipitous three-year market downturn that began in 2000, institutional investors are relying on hedge funds for absolute returns with low correlation to the traditional asset classes," said Victor Leverett, director, hedge funds, Russell Investment Group.

Between 2003 and 2005, the percentage of institutional investors using hedge funds grew from 23% to 27% in North America, from 21% to 35% in Europe, from 18% to 32% in Australia and from 41% to 59% in Japan. By 2007, institutional investors in North America expect to dedicate 9.1% of their portfolio to hedge funds, an increase from 7.7% for 2005. Similar changes are anticipated in Europe, Australia and Japan, where this figure is forecasted to rise, respectively, to 7.2% from 5.3%, to 6.6% from 6.2%, and to 11.4% from 8.1%.

2. Hedge funds of funds have convincingly become the investment vehicle of choice for hedge fund allocations. Among North American investors using hedge funds, a full 91% now invest in hedge funds of funds, while only 41% of tax-exempt institutional investors invest in single hedge funds — a substantial drop from the 82% and 83% seen in 2001 and 2003 respectively. Most other geographic regions have followed a similar pattern in selecting their hedge fund investment structures.

3. Allocations to private equity are forecast to reach new highs in all markets in 2007, with markets that have traditionally had lower allocations to private equity (Europe and Japan) showing the largest expected increases. European tax-exempt institutions currently allocate 4.5% of their investment portfolios to private equity and are planning to increase to 6.1% in 2007. The mean strategic allocation for private equity in Japan, which stood at 2.4% of total assets in 2005, is forecast to jump to 4.5% in 2007. European and Japanese allocation expectations remain lower than in the United States, where investors anticipate private equity will account for 7.9% of total assets in 2007.

"Institutional investors have an increasing appetite for and willingness to seek out the higher returns that private equity has historically provided, and there is a greater acceptance of the liquidity and risk profiles for this asset class," said David Braman, senior partner, Pantheon Ventures, Russell Investment Group. "In Europe and Japan, the preferred route for private equity investing is through funds of funds, while in North America and the United Kingdom, the use of single-fund partnerships has increased."

4. Japanese respondents are buying into the established North American private equities market. Although their total commitment to private equities is currently low — only 2.4% average among respondents — it is expected to nearly double by 2007, with 76% of commitments directed outside developed Asian markets and with 60% of investors favoring funds-of-funds. Private equity use in Japan may accelerate in the future due to favorable structural and regulatory changes.

5. Real estate represents the largest share of alternative investments in Europe and Australia at 60% and 57% respectively. In North America and Europe, respondents' use of real estate in allocation strategies remained virtually unchanged since 2003, with 55% of North American institutions and 66% of their European counterparts investing in real estate.

Institutional investors in all regions except Australia anticipate raising the percentage of their total assets invested in real estate in 2007. In North America, the forecast rises from 6.7% in 2005 to 7.3% in 2007. For European and Japanese institutions, these numbers are expected to rise from 9.8% to 10.5% and from 3.4% to 6.1% respectively. In Australia, the number will dip from, 10.4% to 9.9%.

"Investors have historically been attracted to real estate for its competitive rate of return, ability to diversify a portfolio of financial assets, inflation-hedging attributes and income-generating capability. Although some regional differences exist, global allocations to real estate remain strong and are generally expected to increase by 2007. This is not an unexpected result given the longer period of experience and familiarity many investors have with real estate," said Karl Smith, director, real estate, Russell Investment Group.

About the Survey on Alternative Investing
Since its inception in 1992, the Russell Investment Group Survey on Alternative Investing has been an important tool for institutional investors in alternative investments — becoming a barometer for industry standards and investment levels. Published biennially, the report helps investors broaden their knowledge about industry best practices, stay abreast of trends and structure their alternative investment commitments intelligently. The 2005 report focuses on determining, on a percentage basis, the types of alternative investments that are being used by investors, particularly the growth and composition of these investments, as well as geographic diversification.

The survey, which targets the largest pension funds, foundations and endowments, is given in an objective format and respondents are asked about their views and methodologies concerning alternative investments. The 2005 survey results are based on the detailed information provided by 327 organizations in North America, Europe, Australia and Japan.

About Russell
Russell Investment Group, a global leader in multi-manager investment services, provides investment products and services in more than 39 countries. Russell manages more than $136 billion in assets and advises clients worldwide representing more than $2.3 trillion. Founded in 1936, Russell is a subsidiary of Northwestern Mutual and is headquartered in Tacoma, Wash., with additional offices in New York, Toronto, London, Paris, Singapore, Sydney, Auckland and Tokyo.

Russell Investment Group is a registered trade name of Frank Russell Company, a Washington, USA corporation, which operates through subsidiaries worldwide. Frank Russell Company is a subsidiary of The Northwestern Mutual Life Insurance Company.

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