German institutionals discussed the trials and tribulations of implementing alternative strategies at today's Uhlenbruch conference in Frankfurt. Martin Steward reports.
Big money German institutional investors have been discussing the challenges they face allocating to alternative investments at the fourteenth annual Uhlenbruch Portfolio Management conference in Frankfurt - but also about the success they have enjoyed with the alternatives included in their portfolios over the past decade.
A series of votes from the audience of finance professionals and investors set the tone. More than 46.2% of around 120 delegates thought that alternatives like hedge funds, private equity, real estate, infrastructure, forestry and clean energy should take up more than 15% of an institutional investor's total portfolio; 63% thought they should account for at least 10%; and only 8.4% put the desired allocation at less than 5%.
But they also acknowledged challenges. Asked to choose among a selection, the delegates rated complexity and know-how as the most problematic (59.7%), followed by regulatory constraints (40.3%), illiquidity (38.7%) and valuation issues (26.6%).
This agreed with the issues identified by the investors on the panel.
Thomas Mehlhorn of the Verband der Bayerischen Metall- und Elektro-Industrie Kapitalanlagen (VBM), which has 20% in private equity, real estate and forestry, said that these were the fund's first steps into alternatives because hedge funds would be more difficult to explain to its board, which meets around five times a year.
"It's much more difficult to explain an investment that has gone up while the market has been going down," he said. Private equity and forestry was more intuitive, Mehlhorn argued - even to the extent that the fund has portfolio of direct funds rather than a fund of funds. "We haven't been able to agree on a hedge fund strategy yet, but when we have the confidence we do plan to allocate."
Daniel Just (pictured) of the Bayerische Versorgskammer (BVK), at €48.9bn the country's largest pension fund, agreed that understanding was the key thing, but noted that it often depended on familiarity and could therefore lead to different perceptions of complexity.
"Our board was more sceptical about the forests than the hedges," he said. "Perhaps that's because many of them have privately-owned forest themselves - and only ever got callouses on their hands for their trouble!"
BVK has 12% in real estate, 5% in hedge funds, and newer, smaller allocations to private equity, infrastructure, timberland and commodities.
Just also commented on the difficulties presented by the fact that alternative investments do not fit into tidy asset class categories. "Our traditional processes for allocation and optimisation meet their limits when we move to alternatives," he said.
"At the moment we are asking how we can get away from classical optimisation towards factor-based allocations. But whereas we as professionals love all this, the committee's eyes start to glaze over," he noted.
"They understand how private equity works, but it's hard to build the bridge to them to talk about regressions and optimisations. We will fail if we keep on running forwards but leave the real decision makers behind us - everyone needs to share the burden of responsibility, and we are really only starting our work on this."
Just spoke about BVK's ambition to expand its portfolio into more private equity and infrastructure, as well as renewable energy; to diversify away from core real estate - "where we see a bit of a bubble" - into value-added and specialist assets like social infrastructure; and perhaps move from funds of hedge funds to direct allocation.
"We are approaching this last one cautiously," he said. "It's important that we make sure we have developed our internal team sufficiently for those decisions."
He noted that each time a fund added an incremental allocation to a new alternative investment, a whole new skillset and knowledge base was required.
That point was picked up by Alexander Mayer of W&W Asset Management and the Württembergische Lebensversicherung, which has 8% in real estate and forestry and 2% in private equity. It now holds these in direct funds, after a shift away from funds of funds.
"We have private equity, we are just now making our first commitments to renewables, and looking at infrastructure," he said. "But covering all of the range of alternatives is tough with limited resources. Should we build an in-house capability or use external advisors. That is a big decision that has to be thought through very carefully."
As well as strategy and manager selection teams, the importance and challenges of building suitable infrastructure for alternatives was stressed. Just said that BVK was getting ready to launch a managed account platform for its hedge fund investments, which has taken months of preparation. Mayer at W&W referred to the establishment of a Luxembourg fund platform.
But all the investors clearly felt that the efforts were worthwhile, and cited benefits from and opportunities in their alternatives portfolios, rather than failures or disappointments, thrown up by the crisis.
Conference delegates agreed that alternatives would increasingly be seen as a necessity for institutional investors. Asked if a traditional long-only bonds and equities portfolio would be able to generate the requited returns within their risk budgets, 53.8% voted "no" against 46.2% "yes".