Are consultants up to speed?
Seeking ways to make their assets work harder in the wake of three years of equity losses, pension funds around Europe are looking more closely at hedge funds. The European Parliament has paved the way for greater access to the vehicles, but are consultants in Europe ready to advise their pension fund clients on how to choose and use them?
The level of knowledge about hedge funds - what is available and how they can best be incorporated into an overall investment strategy - varies widely. Generally, it is the larger international consultancies that are the more prepared for client interest in hedge funds and have greater resources on the products.
Andy Barber, European head manager of research at Mercer Investment Consulting, says Mercer has maintained lists of hedge funds of funds for some time. At 400 funds, it is a good universe, he says. Those smaller consultancies that do deal with the field of hedge funds, he speculates, would have to be more selective in the funds they monitored.
Mercer also has clients who are interested in single-strategy hedge funds, and has, for several years, also kept rating lists of these vehicles. The strategies that the firm monitors fall into a number of categories, and tend to be those that are or might be of use to pension fund clients.
“I can’t pretend we could create a hugely diversified portfolio built of every type of hedge fund strategy,” says Barber. But as this is not what pension funds would ask for, there is little point in devoting significant resources to this. “At the moment, most pension funds who are going into hedge are looking for funds of funds, and sticking to strategies they understand.”
Many traditional asset management houses are now offering absolute return tactical asset allocation funds, which are in effect global macro funds. Mercer has coverage of these, and strategies such as market neutral and equity long/short. “Quite a lot of houses are going into this area,” he says.
With the traditional managers moving into hedge funds in this way, it is important for consultants to keep abreast of staff movements. Traditional asset management houses are often unable to give individual managers the level of reward they would get if they moved to a boutique, says Barber, and this can mean that a good manager will not necessarily stay put.
Most local branches of international consultancies point to their hedge fund specialists elsewhere around the globe.
One of Aon Investment Consulting’s specialists is Marianne Bjerke. “Globally, Aon Investment Consulting has carried out hedge fund of funds research for almost a decade,” she says. As an entry point to hedge fund investments, the fund of funds route seems to be the most suitable, because it lets trustees get to know the characteristics of the underlying strategies–their risk return profiles in particular. At the same time, funds of funds also give a high level of diversification and are only moderately risky.
But researching hedge funds and hedge funds of funds is only one part of the process consultants have to conduct if they’re going to advise pension clients on hedge fund investments. “Given the liability driven nature of UK pension funds, it is essential to model the effect that absolute return strategies has on the overall assets and liability profile of a pension fund,” says Bjerke. “To ensure this we have developed and refined our asset and liability models to incorporate this."
The pensions industry in the UK hasn’t been quick to embrace hedge fund investments, she says, but things are nevertheless changing. Her firm has noticed that the more sophisticated trustees become, and the more knowledgeable about investment, the greater their appetite for alternative investments such as hedge funds.
Hedge funds have often been seen as unsuitable investments for pension funds. Some have said the liability-driven structure of the UK defined benefit market and its reliance on relative return and index benchmarks is incongruous with the absolute return-driven objectives of hedge funds.
“We believe this is changing quickly,” says Bjerke. Hedge funds have started to gain credibility as a potential investment for pension funds. These days, they are more transparent, have longer track records, better oversight and people now understand more how they work. And the derivatives markets that hedge funds rely on have developed significantly.
This has meant more opportunities for linking the uncorrelated alpha generation of a hedge fund with the beta-driven returns of the equity markets, she says, through the use of futures or swaps, or ‘portable alpha’. “This makes for a potent combination, which when constructed correctly offers pension funds the chance to better combine the absolute return objectives (alpha) of a hedge fund whilst still maintaining the full market exposure to a desired equity market (beta).”
Aon sees this as a significant area, which is going to attract the interest of UK pension funds. “We aim to be in the forefront of research and developments in this area,” Bjerke says.
In general, she believes the UK consultant industry is ready to advise on hedge fund investments -– and has been for some time. It’s the job of an investment consultant not only to advise clients on current investment strategies and trends, but also to keep abreast with development in financial markets and how they can be of use to clients.
But in Belgium, for the moment at least, hedge funds are very little used by pension funds, says Jos Verlinden of M&P Consult. And there is very limited scope for the funds to use hedge funds – just two or three%.
Pension funds in Belgium are still relatively small compared to those in the UK. Total pension fund assets lie somewhere between e10bn and e15bn. Apart from this, investment is almost totally outsourced to banks and other institutions. Investment strategy has remained very conservative, with much investment in fixed income, says Verlinden.
In Italy, consultants have a long way to go before they really are knowledgeable enough about hedge funds. Daniele Pace of Tailor Consulting in Milan says: “In my opinion, a long way has to be walked by consultants - at least in Italy - to be able to consider hedge in AAS, AAT and risk management. This is a pity because some kind of hedge, market neutral ones, for example, could be very suitable for Italian institutionals.”
But despite the new legislation, there are hurdles ahead for pension funds wanting to use hedge funds as part of their investment strategy, says Pace. “There is, in addition, a problem of liquidity and marked to market valuation of hedge to be changed to make them compatible with the legislation on pension funds,” he says.
Hedge fund investment will not be a new path for pension funds in all countries. In Sweden, for example, pension funds have been able to invest in hedge funds long before this new EU-regulation, says Gustaf Rentzhog of Carnegie Pension Consulting in Stockholm.
“Most pension funds that have been investing in hedge funds have invested a small proportion of their capital in hedge funds and the most popular form has been funds of funds,” he says.
In France, local investors who are getting involved in the hedge fund area are mostly interested in multi-management for hedge funds, says Michel Piermay of Fixage in Paris. But despite the EU go-ahead, hedge fund investment is still some way off in a broader sense. Although local regulations are changing for distribution, they have not yet changed for investors, he says.
Consultants have some assignments, he says, but these are mainly for experimental purposes rather than immediate intentions to invest.