Types of Hedge Fund Investors

ment, were initially reluctant to pay the higher management and incentive
fees charged by hedge funds.
Pension fund investors have also been risk-averse investors. In moving
assets into hedge funds, pension fund trustees have relied on consultants to
aid in selecting and monitoring hedge fund investments. Pension funds are
also likely to invest in funds of hedge funds, to get the benefits of both the
diversification in a fund of funds and the expertise in reviewing and moni-
toring hedge fund investments. Pension funds have discovered that in the
world of hedge funds, the managers that produce the best returns often
charge higher fees, but the net performance on these funds is still higher
than hedge funds with lower gross returns.
Like other tax-exempt hedge fund investors, pension funds may be
charged UBIT on hedge fund returns if interest expenses are high. As a re-
sult, pension funds generally avoid investing in hedge funds that have high
leverage. They also are reluctant to invest in most arbitrage strategies, even
though the risk/reward characteristics of these strategies would appeal to
the trustees.
INSURANCE COMPANIES AS HEDGE FUND INVESTORS
Insurance companies in the major financial centers of the world control
large amounts of financial assets but they are not large investors in hedge
funds. Insurance companies themselves have two sources of funds that
might be invested in hedge funds. First, insurance companies have capital,
much like any other kind of business. This capital is generally called sur-
plus. The second source of investment dollars is the deferred amounts set
aside to pay future claims, called reserves. The payments are delayed for a
variety of reasons. In many cases, the amount payable will be determined
by a lawsuit that has not yet worked through the judicial system. Insurance
companies invest the money set aside to pay claims and use the investment
returns to help pay the settlement amount.
All of these balances could arguably be invested in hedge funds. Insur-
ance companies can invest a limited amount of their funds in common
stocks, real estate, and other potentially risky assets. With the average
hedge fund less risky than the S&P 500, an insurance company could find
hedge funds that would fit well into an insurance company portfolio. In
practice, these portfolios are invested almost entirely in bonds, with small
allocations to stocks and very little in alternative assets. Insurance regula-
tions reinforce this bias toward traditional assets.
Insurance products offer significant tax advantages that could be
Types of Hedge Fund Investors
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