Risk & Portfolio Construction: ‘The wake-up call was 2008’
In April 2010, PGGM decided to build its own managed account platform (MAP) using know-how and technology from veteran Lyxor Asset Management. It had been investing in hedge funds for its clients since 2003 – they account for about 3-5% of total assets.
“The fundamental rationale was to obtain a return stream that was uncorrelated with our traditional assets of equity and credit,” explains PGGM’s head of hedge funds Jan Soerensen. “The wake-up call for that was 2008. Some of what we thought would be uncorrelated turned out to be reasonably highly correlated on the downside. Consequently, 2009 saw a thorough analysis of the way we invest in hedge funds. We came to the conclusion that there were two things that needed to change if hedge funds were to remain an attractive proposition, and one was the strategic benchmark for the portfolio composition – moving away from more directional strategies towards more complementary strategies such as global macro and CTAs, and even dedicated short-selling.”
Add that to the additional layer of 1-and-10 fees that the typical diversified fund of funds charges and the case for going direct was strong. But why take the managed accounts route rather than simply moving from funds of funds to individual pooled funds?
One advantage is that MAP investors get daily position-level transparency. That becomes more important as you move from assuming that the hedge fund ‘asset class’ always diversifies towards wanting to interrogate which strategies really are non-correlated, and monitoring their ongoing correlations.
PGGM also has a more explicit risk management requirement around responsible investment, from which its pooled hedge fund investments previously had to be exempted.
However, where ESG is concerned it is really the ‘G’ that lies at the heart of the decision to use managed accounts.
With a normal LP fund, you subscribe to an entity which, although legally separate from its manager, commingles investors’ money together, uses counterparties and an administrator selected by that manager, and is governed by a board of directors whose independence from the manager and engagement with the fund is often open to question. With a managed account, the responsibility for all of that falls to you as the holder of the account, which is segregated. The manager is merely the trading adviser to that account.
Remember that Soerensen said there were two things it needed to change in the wake of 2008? This was the second.
“When the crisis hit, we found that managed accounts were the only structures that presented us with no problems,” Soerensen recalls. “The other structures were vastly inferior when it came to protecting our capital, in our opinion: we could be faced with gating, suspensions of redemptions and, in some cases, we even saw some fraud.”
In addition to being able to impose its own operational and governance standards via this platform, PGGM also brings much greater negotiating power to its relationships with administrators and prime brokers but also broadens the range of managers from which it can select. In the pooled-fund world, you might find a fantastically gifted fund manager that you cannot invest with because he uses a lesser-know administrator or auditor, or the ‘wrong’ counterparties. But he can advise your managed account, which will use service providers and counterparties that you have chosen.
“The structure has allowed us to go ahead with much smaller managers than we were able to with commingled funds,” says Soerensen.
If the allocation to hedge funds is large enough, the significant ongoing cost savings from a MAP or individual managed accounts can promise not only to pay for themselves, but also to remove an artificial constraint on investment strategy.
“I really don’t see any drawbacks to utilising managed accounts,” as Soersensen puts it, “assuming that you are ready to invest in the infrastructure and people that you will need.”