While institutional investors continue to move into alternative asset classes, funds that experiment with small allocations to private equity, hedge funds, and real estate might be taking on new cost and complexity with little chance of a meaningful return warns financial services consulting firm Greenwich Associates (GA).

The results of Greenwich, Conn.- based firm’s 2004 investment management research — including updated allocation levels — will be released in coming weeks.

In the meantime, GA says that at the allocation levels reported by global institutional investors, even the better-than-expected returns from alternative investments will only have a minimal impact on the risks and returns of a fund’s total portfolio for most institutional investors.

“Dabbling in alternatives demands a disproportionate amount of resources for monitoring and managing,” says GA consultant Rodger Smith. “There is little hope of justifying that effort without more substantial allocations. Very large funds have the resources to do this, but midsize funds may need outside help and will benefit from fund-of-funds structures.”

GA interviewed 2,475 institutional investors in the United States, Europe, the United Kingdom, Canada, Japan, and Australia, and asked them about their asset allocations and use of investment products, including alternative assets. The findings of this research are summarized in a White Paper.

Global institutional allocations to alternative investments increased by about 1% last year, with institutions in Australia and Canada leading the way at 14% and 10% of overall portfolios, respectively. Despite this worldwide growth, however, the consultants at GA observe that many funds remain at allocations far below levels at which they will have a bearing on overall returns.

“If your goal isn’t to get private equity and hedge fund allocations in your portfolio to at least 10% — and 15% is even better — then know your plan to get there, or don’t go there at all,” says GA consultant Chris McNickle. “Without a significant minimum allocation, it will be impossible to fully benefit from diversification.”

In last year’s research, 40% of U.S. pension funds reported using private equity in their portfolios — the highest in any market, followed by about one-third of investors in Australia and Europe. British and Canadian usage is lower.

United States, European, and Canadian pension funds all reported that about 1% of portfolio assets were invested in hedge funds last year.

Real estate allocations are highest in Australia, at 10.2%. Year-on-year increases in the United Kingdom, continental Europe, and Canada are evident in this year’s reported allocations, and the asset class now accounts for about 6% of average portfolios in each of these markets.