Making a beeline for activist hedge funds
his month's Off the Record looks at the question of whether pension funds should profit from the aggressive activities of hedge funds and private equity funds.
Joop Wijn, the Dutch minister for the economy, recently warned that some investment funds "behaved like locusts devouring companies one after the other". His comments followed calls by two activist hedge funds to break up the €11bn Dutch supermarket group Ahold.
Wijn's comments echoed those made last year by Franz Müntefering, the German Social Democratic Party chairman, who compared private equity firms to a swarm of locusts.
In Sweden, the former prime minister, Goran Persson, warned during the run-up to the elections that a social democrat government would prohibit Swedish pension funds from investing in activist funds that target the country's leading companies
Persson's warning came after Cevien Capital, a Swedish activist investment fund, tried to acquire a 5% stake in Volvo, the vehicle manufacturer that more than any other company perhaps is regarded as a ‘national champion' in Sweden.
Persson was critical of the fact that the state AP pension funds were among the backers of activist hedge funds.
His main criticism of pension fund involvement in activist funds was that it breached their fiduciary duty. "They should have a more long-term perspective. If anyone can have a long-term perspective it's the pension funds. If they don't have it, then who will?" he said.
At the same time, European regulators are voicing their concern about pension funds' exposure to private equity. The Dutch central bank (DNB) has warned that debt taken on by private equity funds in leveraged buyouts (LBOs) of companies was exposing pension funds and insurers are being exposed to greater risks.
So should pension funds be involved in hedge funds and private equity firms that actively intervene in the management of companies? We wanted your views. From your responses, it became clear that the question of whether pension funds should invest in activist investment funds was in fact two issues. The first is: ‘Should pension funds invest in hedge funds and private equity?' To which the answer is generally "Yes". The second question is ‘Should pension funds be active owners of the companies they invest in?' to which the answer is also ‘Yes'. It seems the combination of the two fairly uncontroversial issues within one issue has created the furore.
One UK pensions consultant puts his finger on the problem.
"I am sceptical about the
growth of hedge funds in general, many are too opaque and too risky. But the specific question of activism is different. Owners have a duty to look at the management of their companies. Activism is good."
The pension fund managers, administrators and trustees who responded to our questionnaire have no time for the kind of political interference represented by Goran Persson's proposal that pension funds should be prohibited from investing in activist private equity or hedge funds. This suggestion is unanimously rejected
One UK pension fund manager points out that it would be wrong to distinguish between types of activism: the active ownership expected of pension funds and the activism pursued by private equity firms and hedge funds on their behalf. "The objection to activism is outrageous," he says. "Pension funds should be active with all their investments, not just hedge funds."
A Dutch pension fund manager suggests that pension funds should be banned from investing in hedge funds "because they
are not transparent" but not in private equity companies. Clearly there is considerable irritation with the idea that political considerations should take precedence over prudential considerations in the way pension fund investments are managed.
A large majority of respondents agree that what pension funds choose to invest in should be dictated by financial prudence rather than politics, although a Swiss pension fund manager feels there might be more to the question than a simple ‘yes' or ‘no'.
Some European politicians, notably the UK's prime minister Tony Blair, have suggested that pension funds should invest a portion of their portfolio in private equity principally because they have a duty to invest in their domestic private companies. Pensions funds are regarded as the engines of growth for domestic companies, both private and publicly listed. A majority of respondents - four in five - do not see this as their role. A UK manager says "the decision to invest in private equity should be based on their risk return characteristics". Yet a significant minority of managers representing pension funds in Italy, France and the Netherlands say that pension funds do have a duty to support their local companies.
Politicians have suggested that
the short term aims of activist private equity firms and hedge funds are incompatible with the long term horizons of pension funds. This suggestion gains little support, with only one in four respondents agreeing.
It is no surprise, therefore, that there is strong support for the suggestion that politicians do not understand why pension funds need to invest in alternative assets such as hedge funds and private equity, with six out of seven managers agreeing.
If politicians need to brush up on their knowledge of pension fund investment strategy, so too do the public. Most respondents think that more public education is needed about the activities of hedge funds and private equity companies.
Just as some politician feel that pension funds should do their bit to support small and medium-sized businesses through private equity investment, so others feel that pension funds have a duty to protect their country's national champions.
Yet this view gets little support Only one in four respondents agree that he Pension funds
should do nothing in their investment strategy that would destabilise or undermine national champions. One manager remarks dryly "Since most of us invest in them, why would we want to?"
Similarly there is minimal support - one in 14 respondents - for the idea that pension funds should invest in domestic private equity before they invest in foreign private equity. One manager of a Swiss pension fund says that "neither should take priority - funds should invest in both".
The only reason for putting one before the other would be to reassure the pension fund trustees, one UK manager suggests.
"Trustees will probably feel they understand their domestic market better."
Most managers are comfortable with hedge funds per se. Only one in nine respondents agree with the proposition that because hedge funds are unregulated and potentially unstable they should represent only a small part of a pension fund's portfolio. One manager suggests that allocation to hedge funds should be "small but significant".
The Dutch central bank's
concern that leveraged buy-outs (LBOs) expose pension funds that invest in private equity companies to too much risk is not matched by our respondents. There is some unease, with one in three pension fund managers agreeing that LBOs do exposure pension funds to unacceptable risk.
One manager suggests the risk
can be removed "if the fund has access to a diversified portfolio of private equity".
Finally, we wondered what you thought of the locusts label. It has been suggested that, rather than locusts private equity firms act like industrious bees, promoting economic growth and creating jobs. Four out of five of respondents agree with this more generous assessment of their role.
So let's hear it for the bees.