UK - The Universities Superannuation Scheme (USS) has awarded a $200m (€127m) hedge fund replication mandate to State Street Global Advisors (SSgA).

The fund, valued at £30.1bn at March 31 2007, revealed the allocation to a hedge fund replication strategy is a "core part of [its] integrated approach to investing in hedge funds".

SSgA said the portfolio is specifically tailored to meet the pension fund's investment objectives, and will be managed on a segregated basis, with the aim of replicating the average performance of a universe of hedge funds using modern indexing techniques.

The company revealed recent academic research into the returns of hedge fund of funds had shown around 85% of returns could be explained by a number of "quite simple" factors, or risk premia, such as credit spread and volatility, rather than the active skill of managers.

As a result, Kanesh Lakhani, managing director for SSgA, claimed it is possible to replicate these factors in a passive strategy to get hedge fund-like returns, but without the capacity constraint and higher costs associated with traditional hedge fund managers.

He pointed out: "Investing in hedge funds presents a number of challenges, for example, selecting today the manager that will outperform in the future; transparency; limited capacity; manager specific risks; and high costs. The hedge fund beta strategy aims to address those concerns."

As a result, Lakhani claimed hedge fund replication strategies could be used by pension funds to separate their alpha and beta investments, as this type of strategy "offers clients the opportunity to adopt a core/satellite approach to hedge fund investing" and will "lead to clients considering investment in alternative beta, in addition to hedge fund beta".

"Increasingly clients insist on separating investment portfolios into alpha and beta returns. The hedge fund beta strategy allows clients to make a passive allocation to access beta and to only pay hedge fund-like fees where they can identify genuine hedge fund alpha producers," added Lakhani.

Michael Powell, head of alternatives at USS, said the scheme is "convinced" of the merits of hedge fund replication as a way of "gaining transparent, liquid and low-cost exposure to the risk premia which drive the majority of hedge fund returns".

"We see this strategy as a core part of our integrated approach to investing in hedge funds alongside our single manager hedge fund programme," added Powell.

The appointment of SSgA follows the strengthening of the USS alternatives team in September, which was described as the start of an "ongoing commitment to alternatives" as the fund has highlighted its intention to achieve a 5% target allocation to alternatives by March 2008. (See earlier IPE story: USS strengthens alternatives team)

SSgA revealed USS is receiving a "unique" hedge fund replication strategy, developed specifically for the pension fund with assistance from hedge fund academics based at the London Business School and Duke University.

In addition, USS has appointed consultancy firm JTP Partners - which helped SSgA develop the proposition - to provide ongoing, independent risk management of the new portfolio.

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