SEI released a global study on Tuesday that found that while institutional investors’ confidence in hedge funds is growing, there is a larger expectation of transparency and risk management from managers.  

The report, entitled “Institutional Hedge Fund Investing Comes of Age: A New Perspective on the Road Ahead,” which was a collaboration with Greenwich Associates, found that in order to retain clients, hedge fund managers need to enhance their risk management infrastructure and risk reporting, and institutionalize transparency policies to attract new capital, satisfy anxious investors, and protect their reputations. It is also critical for fund managers to communicate with clients about how their investment strategies are a value-add for investors’ portfolios, in order for managers to differentiate themselves.

Meanwhile, 54% of respondents said that they plan to increase target allocations to hedge funds over the next year, indicating their confidence is growing. But investors need to feel certain that transparency and risk management are being taken seriously. In fact, 75% of respondents said risk management infrastructure is the second most important hedge fund selection criteria this year, although it was not even in the top in last year’s report. At the same time, 79% said that clarity of investment philosophy was “very important,” a sign that understandable investment strategies are of the utmost importance to investors.

“The study confirms what we have been seeing and hearing from our clients -- that investors are committed to hedge funds, but managers must get and keep investors comfortable with their investment decision,” said Phil Masterson, Managing Director for SEI's Investment Manager Services division, in a statement. “Managers must differentiate themselves through increased transparency, enhanced risk management, and reporting as well as better overall client service to gain and retain assets post-financial crisis and post-Madoff.”

Seventy percent of respondents said their biggest worry was a lack of transparency, up from 56% in 2009. Meanwhile, more than three out of four respondents want risk analytics from managers, a category that didn't even appear in the top 10 last year, the firm said. And 58% said liquidity risk was their biggest worry in hedge fund investing.

At the same time, 30% of respondents cite “limited regulation” as a primary concern of hedge fund investing.

“The hedge fund managers best equipped to compete prospectively will be those able to clearly articulate their value proposition and source of alpha, as well as demonstrate institutional-quality operations and risk management infrastructure,” says Masterson.