Alternative investments now account for 31% of pension fundsÆ asset allocation, says KMPG, but the bulk of this is still managed by traditional long-only fund management companies.

This demand among pension funds for diversification and absolute returns is a major driver of convergence between long-only and alternative fund managers, with firms adopting strategies usually associated with the other.

KPMG released a survey that included responses from 61 pension funds, 239 investment managers and 48 fund administrators in 28 countries. Its main conclusion is that convergence is the dominant trend in funds management û perhaps not the most shocking news for market participants, who have been busy eating into othersÆ turf for the past decade.

But it does underline the extent to which pension funds are diversifying. Before 2003, the bulk of them kept to a basic 60/40 stocks/bonds allocation. Now the average asset allocation includes 12% to real estate, 8% to structured products, 5% to hedge funds, 4% to private equity and 2% to infrastructure. Pension funds confirm from recent practice that more diversification improves overall returns.

By far the biggest managers for these allocations are the same old traditional long-only names, says KPMG, although it doesn't quantify this. Long-only firms have done well by mimicking alternative boutiques while offering their usual institutional safeguards in areas like risk management and reporting. The bigger hedge-fund and private-equity groups, in turn, have fared well when they institutionalised.

Pension funds have fairly reasonable expectations about returns. Most reckon annualised returns for their total portfolio should be in the high single digits, with only 5% expecting total returns in the range of 11%-13%. This last category consisted of the biggest US pension funds with advanced governance structures and the resources to undertake a more radical diversification into alternatives.

Convergence is likely to continue, provided firms on either side of the traditional/alternative divide can find enough experienced people to replicate products or processes, without losing their way when it comes to their core products. And market turbulence can slow diversification by pension funds.

KMPG reckons the same asset classes will see the most demand in the next few years: real estate, long/short equity, infrastructure; and in the long-only world, global tactical asset allocation, global fixed income and long-only high-alpha products.