Alternatives making a little headway
In Italy, investment rules for each pension fund differ according to what type of legal regime it falls into.
The most recent funds, formed under the 1993 pensions law, cannot in general invest in alternatives – they can only do so via harmonised mutual funds linked to traditional asset classes.
But the arrival of Ucits III, which allows investment funds marketed onshore to hold
a wider range of instruments such as
derivatives, means these funds will now effectively be able to invest in assets such as hedge funds. However, older funds and those covpering specific professions can however invest wherever they want.
“There is definitely an interest in alternative investments, especially from the largest pension funds,” says Monica Basso, sales manager, institutional department, Pioneer Investments. “For example, the doctors’ fund is already investing in alternatives.
These pension funds invest directly, through funds of funds, and also through structured notes, which are bonds issued by highly-rated banks carrying a capital guarantee, but also offering some participation in market gains.”
In addition to their relaxed legal regime, these funds are set to receive a substantial
portion of TFR payments (the annual sum of money set aside by the employer to be paid to the employee when he leaves the organisation), which should further boost their ability to invest in alternatives.
The older, single-company pension funds - dominated by those for the employees of the big Italian banks - also enjoy few investment restrictions on alternative assets.
“They invest mainly in hedge funds - largely through funds of funds - and some private equity,” says Basso. “I’d say that around 3 or 4% of their assets are in alternatives.”
Sergio Trezzi, Invesco’s head of business
development in southern Europe, says: “Demand for private equity has not changed much over the past two years, with major interest showed only by very large pension funds. As for hedge funds, they have often been seen merely as a way of increasing the diversification of asset allocation, in order to stabilise annual returns.”
He says there are two major reasons for this lack of interest. “First, alternatives are not as liquid as traditional assets, making it difficult to produce monthly or quarterly valuations for pension fund clients,” he says. “Secondly, the value of assets under management of many pension funds is not yet high enough to make use of all the opportunities for diversification.”
But he points out that the arrival of Ucits III should have an impact.
“This makes it possible to offer new total return solutions through traditional funds which are more transparent and liquid. This will therefore give a wider range of available solutions to cope with the current pressure on real returns compared with the past.”
Lorenzo Goldberg, managing director, southern Europe, partnerships and distribution alliances, Russell, says: “Until recently, Italian pension funds have been invested in fixed interest securities because of extremely high interest rates. About 70% is still in fixed interest, but there has been an increase in the use of equities.”
But he says that since the massive corrections of the equity markets in 2000, investors have been moving into non-correlated markets, such as multi-strategy hedge funds, which are at the lower end of the risk spectrum.
As a whole, he sees increasing interest from pension funds in hedge funds, private equity, commodities, portable alpha and currency.
But according to Goldberg, it is not only the existing legal framework which makes it difficult for some pension funds to consider alternatives.
“They are not widely used because people aren’t completely familiar with them,” he says. “Many pension fund trustees come from the old school. They are union and company representatives, politicians and independent advisers, rather than market professionals, so no new ideas are going to get adopted without a big educational push.”
Andrea Canavesio, partner, financial advisers Mangusta Risk, says: “Those pension funds which go into alternatives do so because of their low correlation to public markets. And in the search for alpha, they provide diversification from a portfolio which is only beta-driven.”
He says that many of the “older” funds
invest in fund of hedge funds, chiefly through Italian (as opposed to offshore) funds of hedge funds, as these can offer tax advantages.
Although private equity has always been a very small percentage of pension funds’ portfolios, Canavesio says it is increasing very slowly.
“In particular, the first-pillar funds for professions are slowly investing in infrastructure funds, either directly or through funds of funds,” he says. “Pension funds usually get returns of around 5% through a low-volatility fund of funds.”
Trezzi says: “On the total return side, pension funds invest mainly in fixed income strategy funds, with various sources of alpha, and with low volatility. In terms of private equity investments, it is mainly expansion stage – in order to reduce the downside risk – with a good geographic diversification.”
He says: “Generally, unless they are multi-section (multi-comparto) funds, the main objective is to do better than the money market by 1 or 2%. The idea is to be closer to the concept of annual positive performance. However, the idea of moving from certain to uncertain return is not yet popular.”
Basso says: “There is a wide range of hedge funds with a large probability of volatility, but pension funds expect a return from hedge funds of Libor plus 400 bp. Meanwhile, last year, the private equity market outperformed the public markets, on average generating a 15% p.a. return. But one drawback of private equity funds is the wide standard deviation between the top performers and the average.”
Where pension funds invest in private equity, Basso says there is a growing interest in environmental technologies such as solar power. “However, few Italian companies operate in this area, so pension funds prefer to invest via pan-European funds,” she says.
Daniela Konrath, partner in the European investment team of Pantheon, and Italian country co-ordinator, says: “Italian pension funds tend to go into private equity through Italian captive structures, or a very local structure. Regulated structures like SGRs (custom-made management companies) provide good corporate governance.”
She says that, in contrast with other European countries, Italian local players are very successful at networking, and have a better market position in mid-market funds than do foreign-run funds.
“There are not many buyout funds,” she says. “Funds focus more on family company succession, and there is now a mid-market IPO market for family companies which want to go public.” And she says: “The returns we get from Italy are outstanding - 30% IIR over the year is typical. However, it is impossible for new investors to get access to some of the more successful funds.”