When the giant US pension fund CalPERS gave the green light to hedge fund investments as part of its asset mix last year (see box), the psychological ramifications were picked up globally.
Pension funds began to take a more serious look at the class and the outcome of their reviews has led to a variety of approaches.
Jan Willem Baan, director of investments at the NLG17bn (E7.7bn), Groningen based KPN pension fund, which also manages money for the TPG pension fund of the TNT post group, believes firstly that the term ‘hedge fund’ needs close examination. “Semantics need to be selected very carefully here. Some people call long/short a hedge strategy, but we are not inclined to do that. We have invested in long/short portfolios which are fully equitised. There is no leverage involved.”
Baan explains that the fund uses external money managers for long/short as it does for all equity investment, investing via two long/short portfolios – both in the US, one of which is managed by State Street Global Advisors (SSGA).
He says the portfolios amount to $200m, adding that the US exposure is due to the importance of the prime brokerage function: “It is better developed in the US market than in the UK and Europe.”
Originally, Baan says the State Street portfolio was managed for two years on a long only basis but that the fund did not feel the strategy was working optimally. “We felt that the stock selection was very good but that the portfolio itself lacked a bit and that had more to do with the segment than the market we were in. This is the solution to the problem because you get the abilities of the manager to make the right selection. By equitising your portfolio with the right large caps stocks you have deleted the problem.”
In future, Baan says the fund wants to do more of the same, specifically on the long/short side. “We like the approach a lot. It’s just normal equity investment, it is not a wild hedge strategy with derivatives and currencies and commodities. I think that most of the work you put into this goes into risk management from our side and this is very labour intensive. You lose on that if you have this ‘cocktail’ approach.”
While the long/short exposure is a minority portion of the fund, Baan notes they are working on increasing it: “We are convinced we want to expand this. When we see opportunities we also want to do this in Europe and the Far East.” And he notes that the Dutch market is generally open to hedge fund investment: “As long as you have a good strategy and can define your goals and your limits, there is no per se ideological objection to hedge funds. You have to be absolutely sure about the risk management aspect, though.”
Arto Sirvio, who runs the pension fund for Finnish telecommunications giant, Nokia, from the Geneva office, says Nokia has allocated 10% of its benchmark portfolio to alternative investment and the fund is currently looking at how to divide this between private equity, venture capital, non-listed shares and hedge fund strategies. “We haven’t determined the exact amounts yet, but at least 2.5% of the total portfolio will be in hedge funds.”
He adds that Nokia will probably go for direct investment: “We think it is more cost effective than paying a middle man. We will probably select one or two managers to do the investment.”
Sirvio notes that one consideration will be market neutral: “When we analyse alternative investments, we are looking for something which gives us the diversification benefits for the total portfolio.”
Also, he sees the advent of increased hedge fund use as part of the prevalence of core/satellite strategies: “I think there is a change of creating more business within hedge fund approaches as more and more pension funds use indexing for most of the portfolio at a low cost. Then, as part of a core/satellite strategy, they put the remaining 5 or 10% where more active and risky bets will be taken. That seems to be the consensus of where the pension fund community is heading to and I believe in this myself – it makes a lot of sense.
However, Joe Barnes, deputy chief executive at the Sheffield-based CMT pension trustee services, managing approximately £25bn (E41bn) for the UK coal industry pension funds, says the fund spent some time considering the types of alternative investment it wished to pursue, but prioritised venture capital investment: “This will remain the focus for now and we already have private equity investment up to an 8% allocation on occasions. Hedge funds won’t really be considered for some time to come. It’s nothing against hedge funds in principle because there are aspects that we find interesting, but it is a question of resources and priorities and one step at a time and managing each stage of the step carefully.” Barnes says that the UK trustee set-up poses some telling questions on why hedge funds should be introduced: “Alternative investments fall out of the normal trustee monitoring governance structure so it is quite difficult to establish what the reasons are for structuring them in. In proportion to the amount of assets involved, and with issues such as leveraging in hedge funds to be tackled, it is very much a case of putting it on the back burner to simmer.”
Conversely, Reto Kuhn, managing director of the Zurich based SFr4bn (E2.6bn) Swiss Air Pilots Pension Plan, implemented a hedge fund strategy six months ago after looking at the question for around two and a half years. Current hedge exposure represents 3% of the entire portfolio.
“We were looking for a non correlated asset class as a top priority and we hope that we now have a very low correlation and well diversified portfolio.”
Kuhn explains that the fund has implemented a diverse fund of funds approach across the hedge strategies with investment in global macro, foreign exchange, arbitrage, long/short and trend-follower styles through 15 to 16 different funds. This, he says, is to ensure that the correlation is more stable than the performance.
“We have a tailor-made hedge fund approach with Geneva-based Unigestion Asset Management. Firstly, we selected the appropriate investment manager, with the main reasons being trust and experience. Then, we worked together to define our goals and they produced simulations for us before we chose our allocations. This should lower the risk of the total portfolio, which was one of our goals.”
Kuhn notes that the investments are currently being strongly influenced by the position of the dollar: “So far, this year we have not done so well and are getting a very low positive figure.”
Nonetheless, he states his satisfaction with the strategy: “We started with 1.5% in hedge funds and we have doubled that already to the SFr60m present levels, which we will double again. We are very happy with the product.”
Kuhn expects the fund to raise its final exposure to around 5%, but qualifies this with the importance of receiving sound information from the investment manager. “It is crucial to get the information directly from the manager of our hedge fund managers. It would be impossible and not very efficient to do this ourselves.”
The strategies determined by European pension funds may not come
close to the ampleur of that proposed by CalPERS, but the evidence is that hedge funds are no longer taboo. And as more funds strive for the low correlation/high reward tactics promulgated by increasing core/satellite approaches, hedge fund exposure in Europe could well become de rigeur.