Until 2004, Spanish pension funds were allowed to invest up to 10% of their free assets ratio in alternatives.
“They had investments in funds of hedge funds, as well as a very small amount in private equity,” says Lorenzo Goldberg, managing director, partnerships and distribution alliances, southern Europe, for Russell. “A lot of the big players in alternatives were selling to the pension funds. Then in 2004, the regulator specified that funds of funds were not allowed any more because they wanted to reduce the overlapping of fees. What has happened has been that pension funds sold their hedge fund of funds, and started to buy individual hedge funds, so that the volatility of their portfolios has increased.”
Goldberg says that where Spanish pension funds do invest in alternatives, single strategy funds are popular, especially macro, long-short and, to a certain extent, event-driven.
He says: “Those who do invest have around 7 to 10% of their portfolios in hedge funds. The big pension funds are looking for higher returns, and buy these sorts of vehicles. However, although the big pension funds are as sophisticated as Calpers, the medium and small funds are a long way behind.
“A growing part of pension fund portfolios is now being taken up by a new wave of vehicles,” he says. “These include active currency funds, portable alpha funds and value at risk (VAR) pro-ducts. Before, no one looked at them, but now that the legal environment is not favourable to fund of hedge funds, the idea is to get an absolute return,
giving money market-plus returns.”
However, Goldberg considers private equity investment to be a tough call. “Spanish pension funds are allowed to invest in private equity funds which are regulated in Spain and also domiciled in an OECD country,” he says. “Again, however, there is a ceiling to the amount they can invest. But where funds do invest, private equity forms up to 5% of their portfolios.”
He says most pension fund investments are in funds of funds, the underlying investments being Spanish-regulated private equity funds.
“Local fund managers are usually preferred to foreign ones,” he says. “It is partly a question of trust, and partly the fact that many foreign asset managers do not speak Spanish and cannot explain the issues which pension fund trustees have to deal with. This is particularly important considering that many trustee boards include union representatives.”
Overall, however, Goldberg does see a possible new impetus towards alternatives, just around the corner. “The sector is already starting to move,” he says.
In Spain, the allocation to alternatives is quite low compared with the rest of the world, especially the US, says Rafael Hurtado, fund manager with the asset management arm of Banco Popular.
Hurtado says: “I’m not very positive on private equity, for two reasons. First, the mark-to-market system is giving us problems because we have to run it on all funds. Second, if you invest in the top-performing funds, that’s fine, but the dispersion in US private equity is much greater than the dispersion in mutual funds.”
“If corporate pension plans become more popular in Spain, then people will invest more in private equity,” says Hurtado. “I am very positive about hedge funds. They can diversify a portfolio and can be an alternative to fixed interest.”
Commodities could be good investments for pension funds, because there are lots of different asset classes, says Hurtado.
Jose Olabarrieta, director for institutional clients, Spain and Portugal, West LB Mellon, agrees as to the main culprit holding back investment in alternatives.
“Pension funds are willing to invest in alternative products but are restricted by the law,” he says. “They are very constrained in terms of investing in fund of funds, which are their preferred type of vehicle. More importantly, the law also restricts the management fees they are able to pay. The limit is almost nothing in terms of hedge fund management fees.”
Furthermore, calculating the total fee and working out if it contravenes the legal limit makes things difficult, he says.
However, new legislation is now being discussed which might see some lifting of restrictions. But Olabarrieta is not expecting too much. “Any new law is unlikely to relax the limit on the amount of management fees paid to the funds, as the regulators do not want to penalise the end-user.”