trustees of bigger UK pension funds believe hedge funds are well suited to today's investment climate but add wariness has kept allocation low
Some of the largest occupational UK pension funds agree hedge funds would be well suited to today's investment climate, but wariness of the asset class by trustees has kept allocation low.
A survey by Investment Week's sister paper Hedge Funds Review, of 15 pension funds, ranging in size between £120m and £3.5bn showed just one fund had invested in hedge funds, an 11% segment, from a £120m investment pool.
The majority of respondents, which included Lloyd's of London, The London Pension Fund Authority, IBM UK, Axa UK, Powergen, The Pensions Trust and TRW, said they would still consider a maximum allocation of up to 10% to be placed into hedge funds.
Robert Howie, senior investment consultant at Marsh Mercer, said: 'There are a fair amount who want to understand how hedge funds work, but a very small number that actually want to invest. Within the second group there are two basic case studies. The first type of pension fund that would seriously consider investing is a large fund that has in-house resources including its own investment teams and the time to spend researching products and managers.
'The second is the pension fund of a financial institution such as an investment bank, where the profile of the trustees is savvier regarding these kinds of investments. We are now seeing a second wave of interest, coming from medium-sized pension funds. The highest allocation I have seen is 15%.' Tony Ashmore, vice president of the Pensions Management Institute (PMI) Trustee Group, also sees the potential in the multi-manager approach, but thought it was not a tried and tested one.
'Fund of hedge funds are not a bad idea, but also a fairly new one. They are not an unreasonable way to invest a pension fund portfolio, but they are certainly the furthest from the traditional means that I would go.'
A fundamental misconception is the belief that hedge funds are themselves an asset class. Both John Gillies, director of consulting at Frank Russell, and Brian St John Hall, investment consultant at Bacon & Woodrow, stress the decision is based on picking talented managers. 'Hedge funds are not an asset class,' said St John Hall. 'We view them as being an extension of long only managers and in this case you pick the manager with the best skill level. About 25% of pension funds do not even believe active management works and as a result, they won't even consider alternative opportunities.
'The trustees need to be educated and it's up to the consultants to educate them.
'They must be told what the pros and cons are and, by the same token, hedge funds must learn that if they want to sell to institutions, these markets are very different to the wealthy individuals they are used to.'
Gillies agreed, saying passive management is still commonplace for pension funds. 'With traditional asset allocation, the manager's skill is a secondary decision. Even if you go passive you can default and capture the equity risk premium. But if you are choosing a hedge fund or fund of funds, the choice is far more to do with the manager's skill.'
Although trustees' responsibilities have grown recently, the opinion that few of them are able to make sound investment decisions is also seen as unfair.
Howie noted: 'It is unfair to expect trustees to have knowledge of an entire universe of over 6,000 funds. It is better to help them gain a knowledge of the mechanics of hedge funds and for them to seek expert advice.'
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