Internal versus external
What is your hedge fund strategy?
Fund manager of the APG
opportunity and APG hedge funds
• Assets under management: €260bn
• Fiduciary manager of DB schemes
• Number of participants: 4.5m
• Date established: 2008
APG started investing in hedge funds in 2002 when it was still part of the Dutch pension fund for teachers and civil servants. Under normal market circumstances, hedge funds are the perfect risk diversifier when added to standard pure equity, fixed income or other alternative investments.
However, we know that in extreme conditions, hedge funds can show a huge correlation with other asset classes and a liquidity crisis like that of 2008 can mean big trouble, and we have been focused on managing often unseen tail risk and thinking the unthinkable from day one.
As part of our monthly monitoring process, we examine the exposure of each investment to a wide range of financial risk factors, especially during crisis periods. In this scenario-based approach, we use a liquidity crisis and a depression crisis scenario and measure their potential impact. If the outcome exceeds specific hurdle rates we take measures. We also apply some overlay hedges on the aggregate portfolio, such as portfolio insurance.
This meant that, although we incurred a negative return in our hedge fund portfolio in 2008, we had great relative outperformance compared with our peers and were not forced to change policy. It was a confirmation of our risk management approach.
We started off managing our hedge fund investments in-house. In 2006, the team was restructured as an independent organisation acting as an exclusive advisor to APG. This New York-based company, New Holland Capital, is more cost-effective because it is more narrowly focused, more transparent and subject to a greater control than a traditional fund of funds. APG’s investment committee approves all proposals, APG Legal is involved in all legal elements and APG Risk Management provides direct oversight of the overall risk.
Our portfolio consists of about 50 underlying strategies and about 40 managers. The majority are managed accounts, which give us greater control, more transparency and cheaper fees. They also allow use of innovative and unconventional hedge fund strategies and avoid the mature ones.
Hedge funds currently make up close to 4% of our clients’ portfolios and have in absolute terms returned about 7% since inception. We are considering increasing our strategic hedge fund allocation, but it will depend on market opportunities.
CEO, ATP Alpha
• Invested assets: DKK513bn (€69bn)
• Danish labour market supplementary pension
• Participants: 4.5m
• DC scheme
• Date established: 1964
ATP has not yet invested any capital to externally managed hedge funds. However, the pension fund is invested in hedge fund like absolute return strategies via a wholly owned subsidiary called ATP Alpha.
The birth of ATP Alpha dates back to 2005 when ATP implemented an alpha/beta separation process. It commenced trading in January 2006.
We decided to run these strategies internally because we felt we would be able to benefit from transparency on all positions and from being able to handle all exposures through one operational structure. We can set things up the way we like - such as the criteria for the teams - and tailor them according to our own needs. You can do these kinds of things to some extent with external managed accounts, but they do not enable you to manage risk as thoroughly, in real time, as we can with our internal structure.
ATP has approached hedge funds differently from its peers by having true internally generated alpha ambitions. Our strategy is to build a portfolio of world-class alpha sources, which is transparent, below industry norm in terms of costs and accommodates a risk as opposed to a capital allocation approach. Moreover, we target a lean internal organisation with a strong corporate culture. We aim to operate our activities using a best-of-breed technology platform and use world-class outsourcing partners.
Our internal hedge fund teams have gradually evolved. Some were part of the transition from the old to the new model but we have since added teams. ATP Alpha today operates with 10 teams and there are more set to join us at the start of 2011. Externally managed hedge fund investments, which will each add to the overall balance of ATP Alpha’s portfolio, will in due course act as a complementary strategy to our core internal business model.
Around 1% of ATP’s total portfolio is invested in absolute return strategies operated by ATP Alpha and the plan is to grow this share up to 4-5%.
While ATP Alpha has not yet delivered a meaningful risk contribution or P&L from the viewpoint of ATP as a whole, just because of its current scale, its start-up track record is good and it certainly has produced significantly diversification. Since inception, and including 2008 of course, we have managed to deliver a return stream distinctly different from traditional risk classes and with a Sharpe ratio of slightly below 1.0 (with a volatility of around 6%).
Head of manager selection
Barclays UK Retirement Fund
• Invested assets: £16bn (€18.8bn)
• Members: Over 250,000π
• Closed DB, replacement hybrid scheme
• Funding level: 77% (Sep 2009)
• Date established: 1964
We believe hedge funds to be an asset class where outperformance is driven by manager skill so hedge funds are an important feature of this aspect of the pension fund portfolio.
Academic research suggests most institutional portfolios could greatly enhance the chance of achieving their return objectives if they increased their allocation to alternatives and hedge funds from current levels.
In our experience, hedge funds have enhanced our risk-adjusted returns. The performance of our hedge fund portfolio for the last three years - including the dislocation of markets - has been almost 7% per annum. Equity markets were only flat over the same time frame with three times the volatility.
Since the early days of investing in hedge funds, it has always been the intention of the pension fund to have direct exposure.
Six years ago the trustees of the pension fund decided to implement a diversification strategy. For this, they set up a proper governance structure with the clear investment objectives for an in-house investment team, which has the day-to-day role of managing the assets proactively and implementing the trustees’ strategy in an efficient and timely manner. The team looks at the entire portfolio across all asset classes including hedge funds, equity, credit and liability driven investments (LDI). It oversees all direct investments. However, we also look to external resources when assessing new opportunities.
The first allocation to hedge funds was made in January 2006. We have built up our hedge fund exposure to the desired level of around 12% since and actively monitor and manage the investments.
As a pension fund we have the flexibility to invest in funds as well as managed accounts. We take a pragmatic approach when deciding which vehicle makes most sense based on a number of factors, but not limited to, such as transparency, liquidity, terms and trading strategy.
At the moment, the majority of assets are allocated directly to hedge funds. We only have one fund of fund allocation, which is small. We are happy with the portfolio but will take advantage when the market offers an opportunity - we might, for example, increase our emerging markets allocation or implement some GTAA strategies.