Increasing the alternative space
Take on the whole alternative concept with anything like enthusiasm. “Only a few large pension funds use alternatives,” says David Hogarty, head of consultant relationships, KBC Asset Management in Dublin, whose alternative offerings include a fund of hedge funds and a market neutral absolute return equity product.
“Over the past five years, the Irish market has been moving in the opposite direction, towards passive investing,” he says. “People think this is safer and cheaper, whereas they are quite sceptical of alternatives.”
Hogarty says that one reason for this suspicion is that few consultants are openly championing the use of alternatives: “Clients tend to be led by advice from investment consultants.” Irish funds proportionately have far fewer professional trustees than, for example, the UK.
“And with a huge trend in the market away from defined benefits and towards defined contributions, it is a challenge to get alternatives included on the list because it is more down to member choice,” he says.
However, he says that pension funds are now more aware of investment risk.
“But although alternatives can be used to reduce the overall risk in the portfolio, the focus on Ireland has been on manager risk, and in the past 12 months people have sought to diversify this by going either for passive or multi-manager products. In fact, manager risk is tiny compared with overall investment risk.”
Paul Brophy, director, AIB Investment Managers, is even more pessimistic. “There was a greater degree of interest in hedge funds and alternative investments two or three years ago, but with the stellar growth of more mainstream asset classes, in the meantime this appetite has now dissipated,” he says.
“There is certainly some talk about alternatives in general, but I have not seen much evidence of a large allocation,” says Evelyn Ryder, investment consultant at Hewitt Associates in Dublin. “We include alternatives in our benchmarks, but a lot of the time they are excluded from the client’s investment strategy, so it’s an educational issue.”
Other reasons for the lack of interest are fees. “They are nothing like what clients have seen in the past, and they are not confident that these assets will deliver net of fees,” and the schemes’ relatively healthy financial strength. “We see alternatives as a tool for reducing volatility, but Irish schemes don’t need less volatility with high alpha – there is less of a funding gap in Ireland than there is in the UK,” says Ryder. “I think this will change over time, but not for another three years at least.”
Private equity is probably the Cinderella of alternatives in Ireland, with little active involvement except from a handful of large pension funds. “Most pension funds have some legacy allocation from a government initiative 10 years ago to encourage pension funds to invest in Irish venture capital funds, but they had a bad experience,” says Ryder. “However, forestry is reasonably popular, but many funds have made initial allocations and not increased them. Hedge funds are the most popular of the alternative asset classes, but then they have had a lot of publicity for a long time.”
Forestry investment centres on the Irish Forestry Unit Trust, set up in 1994 to target exempt investors such as pension funds and charities. Its assets, worth v38m in 1994 have grown to e150m.
“The aim of the fund is to provide a steady real rate of return with low volatility,” says Brendan Lacey, the fund’s chief executive. “It is more like an index-linked gilt in terms of performance than the other types of asset we’re grouped with.” He says the fund is aimed at larger pension funds and that the highest allocation to forestry in their portfolios is 3%. However, some smaller pension funds invest through managed funds.
“We could take in more money than we could invest in Ireland,” says Lacey. “Up to the end of last year, we bought forests exclusively in Ireland but the supply is limited, so we have now invested e3m in the UK.”
One pension fund with an active alternatives programme is the Smurfit Kappa Group scheme. It has held private equity for eight years, forestry for longer, and has within the past two years adopted a global tactical asset allocation (GTAA) strategy, besides buying stakes in hedge funds.
Of the fund’s e150m portfolio, 8% is in hedge funds and GTAA, 5% in the Irish Forestry Unit Trust and about 1% in private equity. The latter is a stake in a Pricoa Capital fund investing in western Europe.
“We went into GTAA and hedge funds primarily to reduce overall fund risk, while hoping to get a reasonable return,” says Kevin Goss, Smurfit Kappa’s group pensions director. “The GTAA has given us exceptional performance in the past 12 months, going up 40%.”
The forestry fund’s target return is inflation plus 5%. “Until two years ago, they were hitting that consistently,” says Goss. “Then there were storms in Sweden, which released extra amounts of timber and lowered the price. But it’s had a very consistent performance. It is effectively an absolute return fund, so has provided some stability when equities were doing badly.”
Goss says the private equity has been the most disappointing of the alternatives, because returns probably did not justify the risk, but that this was partly because of timing.
The fund includes property in its total allocation - 20% - to alternatives. “Using alternatives as a means of reducing risk was attractive to our trustees,” says Goss. “That drove the overall allocation, which will stay the same for the time being.” The risk reduction role of alternatives has taken on a particular significance at a time the fund is considering a shift from equities to bonds, says Goss.
“We believe that bonds are currently expensive,” he says. “So the dilemma is how do you decrease equities and increase bonds when bonds are so expensive? What do you do while you are waiting, given that equities could lose value overnight? We looked for alternative assets to shelter them.”
The e19bn National Pensions Reserve Fund entered the alternatives market as recently as 2004, when trustees decided to increase return without changing the fund’s risk profile. Around 18% has been allocated to alternatives. Besides an 8% property allocation, there is 8% in private equity, 1.5% in commodities and 0.5% in forestry.
So far e196m has been committed to three private equity funds, run by CVC, Vestar and Clayton Dubilier & Rice. It is intended to increase this to e2bn by the end of 2009, when the fund is expected to be worth e25bn.
However, the NPRF has decided not to invest in hedge funds at present. It says this is because of the rapid growth in the asset class which could crowd out successful strategies, the difficulties in identifying consistent top quartile managers and the lack of regulation of the sector. The fund has also allocated e200m to public private partnerships.
The Smurfit Kappa fund has recently approved a shift from equities into PFI-related investments via a vehicle such as the Henderson PFI Secondary Fund, which pays a dividend as well as giving potential for capital gains.
In spite of this activity, however, KBC’s Hogarty does not see the alternatives sector becoming a mainstay of Irish pension fund investing. “It will definitely increase, but I don’t think it will ever be a significant part of the aggregated pensions market,” he says.