Measuring the alternatives
It is interesting to see that some new indices have just been created to measure some of the fastest- growing asset classes in alternative investment strategies. Zurich Capital Markets in conjunction with Schneeweis Partners has just created the Zurich Hedge Fund Indices. With Swiss and US institutional investors leading the way in investing in these asset classes it is entirely appropriate that the US subsidiary of a leading Swiss insurance company should introduce the new indices.
Hedge fund indices are not new but this appears to be the first time that anyone has brought out an index specifically targeted at institutional investors in the sector.
But what should institutional investors look for in a hedge fund index? An obvious answer is that it should be constructed using only those funds and managers most likely to be considered for investment by institutional investors themselves. According to Zurich this means liquidity, transparency and return consistency within a predefined hedge fund universe. That universe should exclude strategies that employ significant leverage or make extensive use of complex derivatives.
The total assets under management in the hedge funds industry are now estimated to be well in excess of $500bn (E581bn) – a huge increase over the past 10 years. The new indices cover convertible arbitrage; merger arbitrage; distressed securities; event-driven multi-strategy, and hedged equity.
The pro-forma returns for January 1998 –December 2000 make very interesting reading. The most consistent style over the period is merger arbitrage and the most rewarding, but with the biggest volatility, is hedged equity with a return of 107% over the three years.
The job of sifting through the funds to create the new indices has obviously been done very thoroughly. For example, in creating the hedged equity index, 499 programmes were analysed with 382 having sufficient track record but only 68 deemed to have sufficient assets. Only 17 made it into the relevant index. Inevitably, the index committee is composed of Americans, but it is reassuring to see that representatives of pension funds and other institutional investors with active hedge fund investment programmes are included on the committee.
It is also the time of year when we look at the returns achieved by other alternative investment strategies and in particular private equity. Results have just been published for both the UK and the Dutch private equity fund industries.
The UK numbers are the more comprehensive, simply because the industry in the UK is so much bigger. The British Venture Capital Association (BVCA) includes 244 private equity funds in its survey and produced a net return across all investment stages of 25.6% last year. Given that the FTSE All-share recorded a negative performance this must be seen as an extremely good return. Probably more relevant, however, are the 10-year performance numbers. The overall return for the period ending December 2000 turned out to be 20.4% a year, with early stage investment producing an impressive 24.5% a year over the 10 years.
The return of the Dutch venture capital industry, as represented by its association, the NVP, was pretty similar at 17% a year over the same period with the buy-out sector producing 22% a year.
Pensioenfonds PGGM has reported an exceptional return of 33% from its private equity exposure in 2000. Is it any wonder that PGGM expects to increase its allocation to private equity to 7.5% of its assets. The Netherlands’ third largest scheme, the Metalworkers, already has an allocation of 6.3% to alternative investments.
ABP, PGGM’s partner in the NIB Capital joint venture and Europe’s largest pension fund, has an exposure of 1.5% to private equity and intends increasing this to around 4% of total investments over the coming years. Given ABP’s size, this amounts to a huge commitment to the sector but does not come close to the sort of exposure that some large US pension funds have.
For example, the $24bn DuPont Pension Fund has a private market (mostly private equity) exposure of nearly 15% and has achieved returns of almost 30% a year on its venture investments over the past 10 years. DuPont may not be entirely representative of US pension funds but it is far from untypical of the largest US corporate pension funds.
With private equity continuing to produce the returns it has over the past 10 years, it is difficult to see why so many European pension funds, with the exception of the biggest, bury their heads in the sand and refuse to have anything to do with the sector.
Still, in the UK, the Myners Report has at least put the subject back on to trustee meeting agendas. I shall look with interest to see whether we will see an increase in alternative investment exposure over the next few years.