New company takes on the challenge of direct investment
ABP claims to be a trend-setter among pension funds in hedge funds, having incorporated the still somewhat feared alternative asset class into its investment strategy some four years ago.
"The initial effort focused on hiring investment talent with hands-on experience in several hedge fund strategies as well as developing comprehensive due diligence processes," ABP says. It adds: "As others have built up in-house teams over the last few years, ABP has stayed a step ahead by pursuing innovative strategies and working actively with managers to create new customised funds, rather than passively selecting from those on offer."
ABP's innovative approach to hedge funds has seen it create a new company to take over the running of its hedge fund portfolios. "We started out in 2002 by creating our own internal team of hedge fund specialists based out of our offices in New York," it says. "But this year, we decided to spin off our hedge fund group into a new company: New Holland Capital LLC. To our knowledge we are the first pension fund to do this."
Its reorganisation of its hedge fund operations under New Holland Capital was largely due to the rapid changes in the hedge fund industry seen over the past few years, ABP explains. It was considered the best way for the scheme to guarantee the continued success with hedge funds. "To ensure the further growth of the portfolio, we required a robust business model," it says. "New Holland Capital is now better able to attract and retain skilled employees, to build scale that is meaningful in the context of ABP's overall portfolio and to further develop specialised systems and infrastructure."
It adds that New Holland is more cost effective, more narrowly focused, more transparent, subject to greater control and better aligned with ABP's long-term investment objectives compared with a typical fund of funds model, the traditional way pension funds invest in hedge fund products. It adds: "The overall goal is a long-term sustainable model that best exploits the present opportunities while maintaining the highest levels of controls and business standards."
ABP's hedge fund strategy is built on five key objectives: high absolute return; low risk; low correlation to other assets; meaningful scale; and controlled operational risk, it says.
The hedge fund portfolio has grown substantially in the past three years such that, although the 3% allocation is still modest, ABP says it is one of the world's largest hedge fund investors. Even more innovative for a pension scheme is the fact that the majority of its €4.7bn in hedge funds is in direct single manager funds, with just 15% in funds of funds.
The first objective of any hedge fund portfolio is to produce strong returns and ABP claims success in this endeavour. ABP targets an equity-like return with low risk, which in today's environment is roughly cash plus 4%. Since 2005, which many believe a challenging time for hedge funds, the overall returns have been equal to cash rates plus 3.3% with direct investments outperforming both the scheme's fund of funds investments and relevant hedge fund indices.
Not only have returns been strong, but they have also been independent and highly diversifying, ABP says. And they have avoided the negative skew associated with many hedge fund portfolios.
ABP and its hedge fund team have continually sought new ways to achieve the desired with non-traditional investments. For example, ABP was an early taker of meaningful positions in catastrophe bonds, where the return is linked to natural disasters, which may be uncomfortable but is well-compensated and fundamentally uncorrelated with other risks in the portfolio. More recently, ABP says it has been working with existing managers to build tailor-made products when a particular market opportunity has arisen. Recent efforts have focused on exploiting mis-pricings in the explosive ‘collateralised debt' markets. ABP expects these types of investments to comprise an increasing share of its hedge fund portfolio going forward.
Hedge funds are an uncertain business and ABP acknowledges that not every period will yield strong risk-adjusted returns. In fact, the nature of hedge funds suggests that painful declines during periods of negative skew brought on by problems with liquidity are part of the natural cycle. However, ABP says the key to success is clearly defined objectives in relation to the risk a scheme is willing to take.
"Strong returns might be the desired output but the necessary input is the careful evaluation and balancing of risks," ABP says. "For this reason, we are at least as proud of the portfolio craftsmanship we have achieved over this period as the returns themselves."
Highlights and achievements
ABP's hedge fund investments constitute a large portfolio and require a lot of supervision and monitoring. Moving from a fund of funds approach, the most common way pension schemes invest in hedge funds, to direct investments through single-manager funds requires a whole new mindset and skills. Creating a separate company to take over the hedge fund portfolios was a substantial move forward. It allows ABP to consolidate and build on the experience it has acquired by bringing its hedge funds investing under one roof. The new company can focus on its systems and business strategy, and its risk management will have minimal impact on ABP's overall risk management.