Burying heads in sand
The attitude to hedge funds among most UK pension funds never fails to amaze me. While happily (or at least willingly) accepting the volatility of equities, most trustees seem too frightened to make an investment in hedge funds, claiming that such an investment would be too risky despite the majority of evidence pointing the other way for the vast majority of these type of funds, especially funds of hedge funds. And even an investment in the more volatile single strategy hedge funds will often serve to dampen overall volatility in a pension funds, as such hedge fund risks and equity market risks are usually uncorrelated.
Some pension fund trustees simply bury their heads in the sand saying simply that they do not invest in hedge funds. What they mean is that they have not and will not take the time to look at them properly, or that simple prejudice against the unknown or complicated has taken over from rational thinking.
However, I can probably accept that a large number of pension funds feel that an investment in hedge funds is simply an asset strategy that is being studied, albeit slowly and for a long time. Many trustees are concerned that they may have missed the boat and therefore feel that now is not the right time to invest in them. But not many funds feel they may have missed the boat with regard to equity investment or that too much money is already invested in long only equity strategies. Yet a third or so of hedge fund assets are invested in equity long/short or market neutral strategies. So why should attitudes vary so much and why should pension funds feel so concerned about some of their managers being about able to hedge their long equity bets with a few shorts? Perhaps that will have to remain one of the mysteries of life.
For all the recent hype, hedge funds have been around for a long time and it is probably a good thing for those that do invest in them that so many other pension funds do not. Let’s face it, there is not really the capacity for too much money to go in to hedge funds too quickly. But we do now have lots of evidence as to how risk adverse most hedge funds are.
Actually it is quite interesting to see how many pension funds do invest in hedge funds. The statistics are not easy to find. The Boston Consulting Group estimated that in 2004 pension funds owned 34% of all global alternative assets.
Mercer Investment Consulting recently surveyed more than 570 European pension funds with $364bn (€288bn) under management. It found that some 13% of continental European and Irish pension funds invest in hedge funds, and believes that this is almost double the number in the UK.
This roughly agrees with a recent Credit Suisse/Tremont Hedge Fund Index study who say they believe that 7% of all UK schemes and 10% of large UK schemes are invested in hedge funds.
However, there are other estimates. Morgan Stanley estimates that over 75 UK pension funds have made allocations to hedge funds, while Greenwich Associates found 14 UK pension schemes that have allocated to single strategy funds and 45 that have allocated to fund of funds.
In fact, Greenwich Associates conducted a very interesting survey in 2005 among over 2,000 investors managing over £7.5trn (€11trn) in assets. Of the 421 UK funds surveyed only 10% were found to have invested with a further 5% planning to invest in hedge fund strategies. Continental Europe was further ahead with 28% already invested and 8% planning to do so, but the really fascinating story takes place in Japan with a staggering 54% of funds already invested in the sector and a further 17% planning to invest.
According to John Capaldi, managing director at Financial Risk Management, the reason for this is that they started their research earlier because of the local market environment: a prolonged equity bear market and very low (zero) interest rate policy in the 1990s. This gave funds an urgent need to find assets that matched liability growth.
Many pension funds therefore embraced market-neutral fund of funds as a fixed-income replacement strategy. This took hedge funds out of the ‘alternatives’ bucket and into the ‘mainstream’. The key point was that pension funds focused on finding cash flows that met liabilities, regardless of the asset class ‘bucket’, and the fact such hedge funds were not ‘bonds’ did not matter ultimately: what mattered was the cash flow.
So what do the UK pension funds that do invest in hedge funds think? Well, one of the biggest UK funds has apparently just gone on record as saying that it will invest more in the industry as their current asset allocation poses a bigger equity bet than any insurance company, bank or hedge fund.
Now that really sounds like a pension fund that has begun to appreciate the risks they have been running.