"The yield that their portfolio is paying them just will not get them to be able to cover their base return hurdles," Tiedemann contends. "That's a structural challenge they face today, and they've been facing it for the last couple of years."
ConvergEx's Colas agrees. "Interest rates are so low that there is no way a pension fund with a straight face can incrementally invest more into fixed income and still talk about achieving a return mandate of 7.5 percent, which is close to the average of what they assume," he says. "It's literally pushing them into riskier assets and into hedge funds."
Sources point to this issue as the reason why institutional investors made large wagers on collateralized debt obligations in the years preceding the 2008 meltdown.
But while investors are expected to bet big on the sector in 2012, experts say they'll take their time before settling on a fund. In many cases, the process of identifying, evaluating and then investing in a hedge fund will easily range between six and nine months, according to Sameer Shalaby, the president of buy-side technology provider Paladyne Systems.
During that period, Shalaby says, investors will be looking into a hedge funds' performance, technology, trading platforms and the quality of its leadership. They'll also investigate a firm's accountants, lawyers, fund administrators and prime brokers before deciding whether or not to invest. "In general the process is tougher, and we expect it to get worse," Shalaby says. "Nonetheless we think assets are going to flow because institutional investors absolutely are all keen to have a component of alternative assets in the portfolio."
The Top Hedge Fund Strategies of 2012
Although 2012 has a decent shot at being a good year for hedge funds, industry participants warn that the year could get off to a somewhat rocky start since the European debt crisis remains unresolved and is likely to cause more volatility. But when the smoke clears, commodity-based hedge fund managers who equip themselves with the best sources of inside information should be in line for a strong year, according to Tiedemann Wealth Management's Tiedemann.
"Commodity managers who have inside information about an underlying commodity -- it is legal for them to utilize that as opposed to equities, in which insider information is illegal," Tiedemann explains. "The managers who have fabulous networks and a really good understanding of supply and demand chains within the commodity space actually have a real advantage -- more so than their equity counterparts."
And despite their exposure to the daily swings in the global markets, long/short equity strategies continue to be popular with investors, though sources caution assets will only flow into funds that have proven track records. "Event-driven and global long/short are two strategies where we're seeing new assets flowing for the first quarter of 2012," says Ron Suber, the head of global sales and marketing at hedge fund brokerage Merlin Securities. "Some managers have proven in 2011 that those strategies do have an edge, work in different market cycles and are garnering new assets."
Investors also are expecting to see decent returns from macro funds -- which invest in a range of assets, including interest rates, commodities and FX -- along with asset-backed funds, sources add. "The general consensus is, global macro funds should do well in 2012 given that there's so many global macro issues out there," Butterfield Fulcrum's Calveley says. "But it's a really tough call, and I think we're going to see that 2012 is a similar story to 2011."