Transparency the hedge issue
On the back of plunging markets, pension schemes have been rudely re-awakened to negative returns for the first time in many years.
As a result, headspinning research papers debating alternative investment, particularly in hedge funds, are firmly back in the ‘in-tray’ of pension fund managers around the continent.
So, where do pension funds look for practical jargon-free advice?
Most look at some stage to their peers for a slant on the daunting complexities of alternatives.
Belgium’s largest pension fund, the e3.5bn Belgacom scheme, is grappling with alternatives in response to an e300m inflow of assets to the fund and a rebalancing of portfolios. Work on derivatives within the fund’s ALM study is being carried out with Dutch consultant Ortec.
And Philip Neyt, director general of the fund explains that as a first step to hedge fund investment the fund is being extremely careful with the input for the ALM model.
“Like in a lot of studies, especially with quantitative models it’s OK if you put in high returns and low correlation/risk, because that is what will come out. You don’t need to be an expert to see that.”
Consequently, he says the fund is building in some worst-case scenarios to the system. “The problem with the alternative asset class is that the track record is rather short. Can it be sustained in the long-term?
“We have seen data from 1990 up until now, but that was an economic period which was rather a bull market, so the question is, how do they react to bear markets and in a crisis? Neyt adds that in a crisis he believes all the correlations will go up, pointing to questions then about the optimisation of the system.
“We will never find enough data on hedge funds, but we want to do more stress testing and know about the whole black box idea on hedge funds.”
He is also wary that ‘hedge funds’ is not a homogenous asset class.
“There are a lot of strategies behind this – some we want, others we don’t.”
Neyt also raises the issue of survivor bias, which he argues is greater in hedge funds, due to the relatively large numbers that go bust.
He also wonders how efficient the derivatives market will be should a flood of pension funds start investing.
“Even I have some doubts. The likes of ABP and PGGM are going into hedge funds and the trend is to go in around 5-10% of assets. My worry is that the inefficiencies will disappear.
“Every strategy has its limits, but certainly with hedge funds. I think we could be confronted with this issue much more easily than we think.”
William Van Impe, general manager of the scheme, says he has immersed himself in academic journals on hedge funds to get to grips with the issues.
“The figures we use in our ALM study are very conservative assumptions on hedge funds. We put in a maximum constraint of 5% and we still end up with 5% - even in the worse case scenarios. But because of the questions surrounding hedge funds we will not start with 5% of the fund.”
He adds that a tender procedure has been started for an initial e50m – a little less than 1.5% of the portfolio. However, he points out that any final decision will have to be cleared by both the board and the insurance control authority in Belgium, which has rules on avoidance of leverage, transparency and safe keeping of the assets – prime question marks in the hedge fund debate.
Another issue, says Van Impe, is the fund’s need to fully understand the risk involved, particularly in the fund of hedge funds approach that Belgacom favours: “We will have to understand what the risks are and how these risks are managed, both by the individual hedge fund manager and the fund of funds manager.”
The fund is also currently investigating the cost factors involved in such a structure.
Van Impe concludes by noting that the hedge fund industry complains that pensions funds are always looking at hedge funds, but that nobody is actually doing it.
He is keen to deflect some of the responsibility back on to the hedge fund industry though. “What we want to give is a clear sign to the industry that we are ready to invest in hedge funds, but that we want a minimum of transparency to understand the risk and see how this risk is controlled.” “ If this is the case then we will make the step forward. Otherwise we will announce that we will not make the step and I think this will be a clear sign.”