Dipping a toe in the water
Investing in alternative assets by French pension funds is still not common. “This is generally due to a poor understanding of alternative betas and especially the restrictive regulations,” says Noel Amenc, professor of finance and director of the Edhec Risk and Asset Management Research Centre.
Other observers point to the relative lack of funded pension arrangements in France, which means there are few funds with portfolios large enough to include the less mainstream asset classes. However, things may be about to change.
“Many of those French pension funds or similar structures which are funded, as well as caisses de retraite - retirement companies - and insurance companies, are on the verge of putting money into private equity,” says
Charles Soulignac, chairman and CEO of Fondinvest Capital, which runs 180 private equity funds, the vast majority investing in Europe, and some secondary funds investing globally. The company has several insurance and retirement providers as investors.
“Interest has grown because they believe that private equity gives some diversification to the total asset allocation as it is not linked to the stock markets,” says Soulignac. “Furthermore, on a long-term basis, it also has the potential to perform better than the public markets.”
Fondinvest’s own funds focus on early stage expansion and buyouts, investing throughout Europe. However, about 20% of the total is in venture. “We aim to get an internal rate of return on our funds of at least 10% to 12% above the returns from public markets,” says Soulignac. “We have achieved that in the past. Another reference for limited partners is the multiples - that is the cash that investors get back divided by the cash they’ve put in - and these have been over two times.”
Soulignac says that French investors want diversification as well as performance, and that going the fund-of-funds route into private equity is an easy way to do this as they can spread risk through a single fund. He adds that it is necessary to have the requisite expertise in this specific business of investing in funds.
The 2005/6 Russell survey on alternative investing underlines this budding interest in alternatives. For the first time, the survey – published biannually and covering institutional investors worldwide – includes French participants, such as retirement providers and insurers.
“There has been a big rise in investing in alternatives, especially hedge funds outside the US,” says Dominique Dorlipo, managing director of Russell’s French office. “The survey shows an increase in allocation to hedge funds and private equity, and this is expected to rise further in 2007.”
Dorlipo says that in 2005, hedge funds were the main beneficiary of the shift to alternatives. “Across Europe, hedge funds were dramatically up in 2005, compared with 2003,” he says. “There was a lot of demand for them, despite the general health of the equity market.”
Although the survey results for each European country are not shown separately, Dorlipo says that, by and large, French pension funds behaved in a similar way to those in other countries that took part in the survey. But there are still some crucial differences between French institutions and those in Europe as a whole.
“The average allocation by European life funds to alternative assets is made up of 60% real estate, 30% private equity and 10% hedge funds,” says Dorlipo. “In France, by contrast, the typical split for life funds is 85% real estate, 3% private equity and 12% hedge funds.”
Dorlipo says that French institutions have a higher allocation to hedge funds than the European average, mainly because of their need for relative short-term liquidity.
“Because the retirement companies are unfunded, their assets cannot be invested on a 25-year horizon,” he adds. “So we have lower allocations to private equity, and a higher allocation to hedge funds.”
Dorlipo says there is also a growing realisation by French investors that they should look at other alternative investments, such as commodities and currency. The global currency market is the largest market in the world in terms of turnover.
“There is a search for alpha everywhere because so many pension funds are in deficit,” says Dorlipo. “So they are looking for assets to fill the gap.”
He says that commodities in particular provide the opportunity to optimise alpha by exploiting inefficiencies in the market. “And the fact that commodities are uncorrelated to the equity and fixed income markets is a big plus in terms of diversification.”
French institutional investors use hedge funds in two ways, according to Amenc. “They are used either as an instrument for managing cash as a complement to their money market mutual funds – SICAV monétaire – in order to improve the risk/return combination, or as a satellite to a core that in general is mostly allocated to bonds,” he says. “The latter allocation remains limited for regulatory reasons.”
For institutional investors, Amenc says hedge funds are often perceived as a low volatility class with returns that are higher than those of bonds. “For those who invest in long/short, the idea is that this investment would allow them to outperform an equity benchmark,” he says.
“Interest in alternative investments is strong,” says Gilles du Fretay, founding partner of investment managers HDF Finance. “But there are some very tight regulations which limit the amount of assets which French pension funds can invest in hedge funds to a small percentage of their portfolios. There is a need for new rules.”
HDF Finance’s clients in its fund of hedge funds products include several French pension funds.
Du Fretary says the most popular of HDF’s funds with French pension funds is its multi-strategy fund, attractive because it is the point of entry for buying into alternative investments all over the world. Despite the hedge fund industry’s high-risk image, Du Fretary says the fund offers diversification and risk control, and can give a high return if well managed. The fund has returned 10% a year over the past 10 years.
However, Du Fretay says that at the moment there is tough competition for customers, with 52 companies in France marketing funds of hedge funds.
“Over the next few years, I expect to see a great disparity in performance between different managers, and the elimination of bad managers,” he says. “Institutional interest in funds of hedge funds and alternative investments generally will continue, especially if the stockmarket stops rising at some point. The French stockmarket has done very well since March 2003. When a stockmarket makes 20% in a year, investing in hedge funds is perhaps not seen as a good thing to do. But it can protect your capital when the stockmarket plunges.”
“The idea that hedge funds are not homogenous and that it is appropriate to select strategies as a function of the ALM objectives and constraints is starting to take root with French institutional investors,” says Amenc. “In time, multi-strategy funds of hedge funds should make way for single strategy funds of hedge funds or indices, selected for the complementary nature of their betas in relation to the existing assets rather than for their past performance.”