Institutional investors represent a growing proportion of global hedge fund assets under management, but compelling performance by managers will be crucial this year to attract strong flows into the asset class, says data provider Preqin.

In the fourth quarter of 2012, institutional money represented a capital-weighted average of 63% of a hedge fund’s AUM, up from 61% in 2011 and 45% in 2008, according to Preqin.

A poll by the research firm of investors globally found that 57% say hedge fund returns met their expectations in 2012, which represents an increase from 2011 and 2010. However the proportion of investors that reported returns exceeding their expectations has fallen to 3%, compared to 11% in 2011.

Despite concerns over returns – which were below industry benchmarks last year – 47% of institutional investors planned to invest up to $49 million of fresh capital in hedge funds over the next 12 months, with 15% indicating they would allocate more than $500 million to the asset class.

With hedge funds, on average, underperforming benchmark indices in the past few years, performance was the biggest issue to be addressed this year, said 60% of fund managers and 47% of investors.

“2013 could prove to be a vital year for the industry," says Preqin, "and hedge fund managers will need to post strong returns in order to satisfy those investors that have been disappointed with the industry’s performance over the past few years.”

In Asia, the situation is similar. Hedge funds in the region saw an estimated $500 million in net outflows on the back of disappointing performance in 2011. While average returns improved in 2012, several big-name managers reported single-digit gains for the year.   

Prime brokerage executives in the region say performance was below what was generally expected of Asian hedge funds in 2012, as managers navigated choppy market conditions.

There is anticipation that inflows to Asia will pick up this year, but investors are likely to need to see two quarters of solid performance before any significant amounts are allocated. (See the March print edition of AsianInvestor for a full report.)

A separate Preqin study of US endowments that invest in hedge funds found that 11% preferred those with a focus on Asia, close behind Europe (14%) but trailing global (90%) and North America (82%).

The average US endowment has about 19% of AUM invested in hedge funds – their largest allocation to any single asset class.

The heavy exposure has been cited as a contributing reason for a slight 0.49% fall in endowment assets to $406.1 billion in the year to 30 June, according to the Nacubo-Commonfund Study of Endowments released last week.

The major factor cited for the dip in endowment returns – which were down on average -0.3% – was exposure to international equities, particularly Europe and China, which performed badly in the run-up to mid-2012.