Sovereign wealth funds, endowments, pension plans -- across the board, institutional investors are rushing into alternative asset classes to escape the purgatory of low returns they expect from public markets over the next few years. But a new report from State Street Corp.’s Center for Applied Research says these investors are failing to make decisions that will help them meet their individual objectives, manage risk and handle the greater portfolio complexity these moves will bring. “Irrespective of their stated goal, institutional investors are exhibiting a herd mentality by increasing their exposure to alternatives,” says Suzanne Duncan, the report’s Boston-based author. “While there is nothing wrong with alternatives, what’s worrisome is that investors feel unprepared to handle the risks and complexity.”

Based on input from more than 3,000 financial industry participants in 60 countries, including 200 face-to-face interviews with State Street’s applied research group, the report also highlights the tougher environment that asset managers still face after the financial crisis. From the 1980s to 2007, their growth seemed unstoppable as institutions diversified out of conservative portfolios and individuals socked away money for retirement. In the five years since the crisis struck, though, retail investors have gotten more conservative despite saying they need to be more aggressive to reach their goals. Meanwhile, institutional investors are adding hedge funds and other complex investments. To stay competitive, asset managers must respond to these wholesale changes.

“Investors are no longer acting in their own best interest,” says Duncan. She stresses that institutional investors of all stripes are pursuing similar strategies regardless of their very different aims.

In the U.S., 45 percent of respondents said low interest rates have increased their desire to add alternatives to their portfolios. In a separate State Street online survey of 100 institutional investors, 56 percent said they are boosting direct allocations to illiquid private markets, including private real estate, private equity and infrastructure. At the same time, when respondents were asked about their biggest challenges, the “complexity stemming from increased investments in alternatives” ranked No. 1.

Duncan says investors’ moves to plow money directly into certain strategies without using external money managers reflects disillusionment with the value they’re getting from intermediaries relative to the fees they are paying. “They’re looking to take matters into their own hands much more aggressively than in the past,” she explains. “They are being driven by artificially high expectations of future returns.”