On the road to respectability
Although the hedge fund industry has grown enormously over the past five years or so, pension funds and their institutional investors have been somewhat slow in warming to it. “The interest shown by the Swedish pension fund industry is a relatively new development,” says Eddie Dahlberg, managing director of the Skr6.5bn (e719m) Volvo Pension Fund in Gothenburg.
Hedge funds have been around for the past five or six years in Sweden, he notes, but institutionals didn’t do much with them simply because they were not accepted within the investment industry. “They weren’t used extensively before because they weren’t really a feature of the Swedish market. But there is definitely something positive going on, given the number of visits we’ve had recently from people trying to sell hedge funds.”
Hans de Ruiter, portfolio manager at ABP in Schiphol, the Dutch civil servants pension fund with e150bn under management, agrees that there has been tremendous growth in the industry as a whole but the number of pension funds plunging into this new asset class remains small. “A recent study into hedge fund assets reveals that assets under management in hedge funds have doubled over the last five years from $250bn (€285bn) to $500bn and looking at the customer base of hedge funds, we witness a slow but persistent trend towards more institutional clients, with pension funds especially showing an interest, but the number of pension funds that have actually already invested in hedge funds is still small.”
As a consequence of this growing interest, de Ruiter believes that hedge fund managers will have to adapt their working culture to the needs of the pension fund community if they are to win mandates there. “Hedge fund managers will have to deal with the specific requirements of pension funds in terms of greater transparency and disclosure as well as a sophisticated risk management system.”
Jane Collins, director of institutional marketing at Credit Suisse Asset Management (CSAM) in London, which has $3.85bn in hedge fund of funds under management, says that there are differences across Europe in the amount of attention given to the inclusion of hedge funds in institutional investment portfolios, but that interest is definitely on the rise.
“We are seeing essentially a lot of enquiry from European institutional clients and pension funds, and this tallies up with information we have from the investment consulting community. There is particular interest in the UK, though we haven’t yet seen sales on a large scale and we don’t believe that there have been any large segregated mandates in the UK pension fund market.” However, things are a little different in continental Europe, where she believes that countries such as France, the Netherlands and the Nordic region are progressively further down the road.
In these countries CSAM has been asked to pitch in three main areas: straightforward fund of funds; advisory work, and (most interestingly) hedge funds as part of allocation strategies within global investment portfolios. Collins points out that these pitch areas are happening concurrently and are not one-offs.
The reasons Collins gives for some countries advancing more swiftly include legislation, culture, and investment history. The Dutch have a long history of investing in alternatives generally speaking and are seemingly very interested in developments in the hedge fund industry. The French market is somewhat different and is likely to remain so for some time. Alternative investments in France are usually guaranteed, since they don’t like to lose money and they don’t go in for long time horizons.
Collins believes that interest in the UK has been stirred by a variety of reasons, but most notably by positive results that hedge fund trading has shown recently. “Interest in hedge funds by pension funds is on the rise in the UK, mainly because of the interesting returns hedge funds have made in the past 18 months in relation to world equity markets.”
Dahlberg believes that cultural rather than regulatory reasons are behind the slow growth among pension funds opting for hedge funds in Sweden. “There are no real restrictions as to the use of hedge funds, it’s just a matter of understanding and getting used to them.”
De Ruiter agrees that culture is a major factor in adopting hedge fund strategies but that pension funds are now less shy because they are better informed. “Many pension funds have become more familiar with hedge funds by means of conferences, articles, books and the experience of peers in the pension fund industry. Nevertheless, the pace is slow, since there is still a gap between what most hedge funds can offer and what pension funds require in terms of information and risk management.”
ABP does not use hedge funds at present but is considering investing in them soon. “When we start investing in hedge funds, we will start off with multi-manager, multi-style fund of funds, since this will provide us with the necessary diversification we require and hopefully manager skill at choosing the best hedge funds to go for.”
Despite the growth in the hedge fund markets, pension funds are still slow in adapting their investment strategies to include them and they are not emerging as an independent asset class in their own right.
Dahlberg of Volvo states that hedge funds definitely have a role to play but that that role will remain restricted. “Volvo uses hedge funds purely as a complement to existing portfolios and we do not regard them as a major asset class. We use only long/short hedge funds.”
De Ruiter says that ABP will use hedge funds to serve three main objectives. They will be used for high returns, which becomes all the more important given APB’s long-term view that equity markets will begin to yield lower returns than over the past 10 years. Then they will be used because they involve low risk strategies and then for low correlation purposes with traditional asset classes. Altogether, this means that hedge funds can offer a fairly marginal return with a risk factor that is close to zero.
Reto Kuhn, director of Swissair’s pilots pension fund in Zurich, with Sfr4bn (€2.6bn) under management says that the main purpose of hedge funds is to get zero correlation with existing asset classes, such as bonds, stocks, private equity and real estate. Swissair’s portfolios make extensive use of hedge funds across 20 funds including global macro, long/short equities, merger arbitrage, currency and short-only.
In the UK, there have been mandates in individual hedge fund strategies but not yet in hedge fund of funds, but this is regarded as an area of future growth. “Some UK investment houses have been quite successful in getting long/short or market neutral hedge funds under their belts from existing clients but we think that the future lies diversified strategies fund of funds business,” says Collins of CSAM.
Some see regulation as a stumbling block, and therefore deregulation as a liberating factor for further development. De Ruiter, however, believes that it is inevitable and will ultimately help the industry grow. “It is to be expected that when more institutional money flows into the hedge fund industry, the market will become more regulated. This is a positive development for the industry since it provides more transparency and protection for pension funds.”
The future looks “rosy” according to Collins, but others are less optimistic. Kuhn believes that there won’t be enough funds for the amounts to be invested. “There is too much money chasing too few top funds.”
Nonetheless, the hedge fund market will grow amongst pension funds, as De Ruiter points out: “We expect hedge funds to get a firm footing within the institutional market in the coming years.”