GLOBAL - The Universities Superannuation Scheme, the UK's second-largest pension fund, is to begin investing in single strategy hedge funds as officials say they can now get access to the big named brands and corporate governance conditions are improving.
Mike Powell, head of alternatives at the £23bn (€27bn) pension scheme, said the fund expects to invest 5-6% of its assets in hedge fund strategies hrough approximately 25 managers over the next two years.
Having invested around £200m in hedge fund replication until now - and generated a return of around 6% through it - officials believe the time is now right to invest in single strategy hedge funds as USS is now able to access the type of large name funds it wants to invest in, and such funds are now keen to take pension fund money compared with 2007, for example, when managers saw significant flows of high net wealth money.
"We had some concern previously about hedge funds due to the asset-liability mismatch.
We have an over-allocation to private equity but the absolute return programme share will increase significantly," said Powell.
"Last year we had a relationship with State Street which was trying to replicate the systemic elements of hedge funds. At the moment, our only exposure is in replication. But our intention now is to launch the single fund programme. We're currently happy with our exposure to replication. One of the reasons we started it was an opportunity to observe the hedge fund industry, and the drive to use alpha. And a lot of the problems in hedge funds have been solved by the recent crisis," added Powell.
Emily Porter, absolute returns strategies portfolio manager at USS, said the time is now right to invest as there are fewer people chasing assets to good hedge funds and while pricing has not dropped as far as some commentators have argued for, pension funds looking to invest long-term are able to gain better terms and fees.
"At the beginning of the year, I think people thought we would be paying much less," said Porter. "But some top-tier managers have opened for money and closed again. The strong managers don't have as much pressure as people thought there would be. So we're very pragmatic. We're not demanding a 1% cut from every manager."
In order to be eligible as a USS investment option, the pension fund will stipulate that a manager must display significant transparency and agree to place its offering on a risk transparency platform, such as that supplied by Risk Metrics, said Porter.
Other platforms are due to hit the market according to Porter and investment managers are now more willing, since the credit crisis and market volatility struck, to consider placing their investments on a platform. So with such developments, it will become increasingly easier for pension funds to argue good corporate governance management is be high on the list of standards for managers to adhere to.
"It now looks like a strong time to start investing, because there are a lot less investors chasing the same assets, it is a much less crowded market. But we think it is quite important to have the transparency in terms of management and in aggregating the risk. We will know exactly what our beta is at the end of the month," said Porter.
Powell said the fund was less likely to consider investing through managed account platforms - a concept which he believes are being portrayed as "a silver bullet for hedge funds" though he disagrees.
"There is a push for transparency but information is only as good as you can use. We think an excellent middle ground is one of these risk aggregators. Our general feedback from managers is there are a lot more receptive to moving onto the risk platforms than they would have been in the past.
As part of its push for transparency, USS will join the call by investors for improved governance within hedge fund boards of directors, according to Porter.
"Corporate governance and the board is something that people are looking at. I haven't seen any changes as yet but there is certainly significant pressure for them to do so. The majority of independent members would be a requirement [for us] and active management, not just named individuals but getting quite involved so we can have any open dialogue. Most investors have had relationships with the hedge fund, but given we have the board we should have a real relationship with them. Of those firms who have looked at it, we have been able to discuss matters with the board," she continued.
In order to enter the single strategy market, the pension fund is adopting a core, tactical and niche investment strategy, though Powell said the plan is to avoid silos as USS does not want to miss out on opportunities which do not fit a particular definition.
The average sum to be invested with each manager will be approximately £50m though that is likely to increase for core offerings - many of which are expected to be larger name offerings - while the money invested is likely to decrease for niche investments.
The long-term plan is to invest 20% in alternatives, but USS still has some way to go as the fund had just over 10% in alternatives at the end of December 2008. At present, its portfolio is overweight in private equity as a result of the denominator effect - making up 50% of the alternatives holding - but that will reduce to 35% long-term while infrastructure will be another 15%, absolute return strategies will be a further 25% of the portfolio, commodities will be 20% and other assets will make up the remaining 5%.
USS acknowledges that its size places it in a position to be able to exploit investment in single strategy hedge funds, but officials believe whereas it is likely to give the more expensive fund of hedge funds (FoHFs) a wide berth, FoFs may be suited to smaller pension funds who do not have extensive in-house expertise.
As part of its move into single strategy hedge funds, Luke Dixon joins tomorrow (1 July) as portfolio manager. He was previously executive director responsible for global hedge funds due diligence on structured products at JP Morgan. A further two analysts will also join USS in due course.