Educating the consultants
Hedge funds remain a murky area not only to European pension fund managers but also to the investment consultants who advise them. Although many in the industry recognise the potential benefits to be derived from investing in so-called alternative investments, few consultants have taken the initial steps necessary to promote them to their clients.
Our experience is that pension funds are always looking for new asset classes with good diversification prospects," says Georg Wessling of Ecofin in Zurich. "Some are looking at hedge funds and we have done some educational work for our clients, doing research and holding seminars."
For all European consultants, education is a high priority. "Most people using the term 'hedge fund' are referring to high-risk investments," says Dan Allen of Wilshire in Amsterdam. "But some are high risk, others are pretty low risk. The first step is to understand the definitions." However, Wilshire, with a largely Nordic and Dutch client base, has not seen much concrete interest in investing in such funds, with the exception of a few large financial institutions.
Ken Ayers of the Frank Russell Company agrees. "On both sides of the Atlantic clients are asking more questions." However, he adds, "There is not a great deal of evidence that our European clients are investing in any significant degree. We are inclined to think that it is more that managers want to keep abreast of developments."
Ayers continues: "When they raise the subject we try to answer their questions. But while we feel obligated to provide answers, there are other areas that are more rewarding of research. We tend to concentrate on those. We are not sure that hedge funds represent the best use of resources" "There is pressure on research re-sources as it is," seconds Sally Bridgeland, head of investment research at Bacon & Woodrow in London. "it will take a lot of pressure from clients to start to look into something new."
The lack of transparency in the hedge fund marketplace is off-putting for many consultants. Hedge fund managers do not always provide the level of documentation offered by managers of traditional investment vehicles, which means that it is difficult to research one company, let alone make market comparisons. In addition, because many managers change investment strategies frequently to maximise returns under varying market conditions, it is difficult to make longer-term analyses of style or performance.
These same factors make investment consultants reluctant to recommend most hedge funds as appropriate investment options for their pension fund clients. "It is difficult to control hedge fund managers. You cannot be sure that they are running the strategy that they have offered," says Ecofin's Wessling. "You need a lot of time to control hedge fund managers and a lot of know-how about the markets. The value-added is too small for it to make sense at the moment." Although investment consultants are wary of hedge funds at the present time, they do represent an area of investment with good potential for their clients -- and a potential business boom for the consultants themselves. As Allen points out, "The room for superior manager selection is greater with hedge funds than with traditional investments." Therefore, they represent an area in which consultants can provide a definite added-value service.
So what do hedge fund managers have to do to convince investment consultants to make a research commitment to hedge funds and eventually recommend them to their clients? In the UK a working partyof the Institute of Actuaries is preparing a research paper, due in May, looking at the risk profiles of hedge funds. Bridgeland is involved in this working party and has been giving the issue a great deal of thought.
"If hedge funds could be developed to guarantee real rates of return, they would be very attractive to pension funds. They would need to have something underpinning their returns based on inflation-resistant gilts, for example," she says. "In addition, the managers have to begin to present information in the way that we are used to looking at it." These means, in part, greater transparency as well as comparable long-term statistics.
The fund-of-funds approach also has potential, "There are so many funds out there that either a consultant of a fund-of-funds is necessary," says Allen. "Most pension funds do not have the resources otherwise."
Those funds that offer market-neutral strategies receive the most positive reception from investment consultants.
"There are some market-neutral strategies where there may be scope if you can identify managers who offer that strategy and you can feel confident that they will remain with that strategy," says Ayers.
However, above all, the investment infrastructure has to be sorted out. As yet there are no agreed benchmarks for hedge funds, an admittedly tricky area since the funds that fall under this rubric vary greatly. In addition they represent a grey area from a regulatory standpoint. In Switzerland, for example, Wessling pointed out that it is not clear whether or not pension funds are allowed to invest in hedge funds. Even in the US, where hedge fund investment is more established, some of the underlying portfolios could cause ERISA problems, points out Ayers."