By Susan Barreto
The discovery of hedge fund gold has fuelled an unforgettable pension fund road trip and is likely to make the pension contribution holiday a little easier to accept politically in the US and globally.
The first half of 2010 has also yielded a pot of gold for consultants eager to provide valuable insight on asset allocation to a growing number of clients. Particularly in the US, the number of searches for investment consultants has hit an all-time high. Perhaps the greater demand for advice even led to some of the legal squabbling between leading hedge fund investment consulting firms Aksia and Albourne, which recently settled a lawsuit over Aksia's claims that Albourne America and two former Aksia employees hired by Albourne removed confidential and proprietary business information from Aksia's offices.
The treasure map used by investors still differs greatly depending on whether traditional consultants work in tandem with hedge fund specialists.
Why the consultant and asset mix mayhem?
Pension contributions into the largest retirement pot of money globally are on the decline because of budget crises at every level of US government. The easy place to cut corners is to not make full contributions to the pension funds since it is not as pressing an issue as, say, funding the salaries of emergency personnel or road construction.
The problem of the pension holiday has a finite time frame. Some argue that it is already over. According to Orin Kramer, chairman of the New Jersey Division of Investment, a speaker at the upcoming InvestHedge Forum in London, the politically unspeakable reality is that public employee pension systems are under-funded by more than $2 trillion. These unfunded promises by state governments to their employees amounts to about one quarter of the US gross domestic product, Kramer says.
Traditionally, pension funds review their asset mix every three years, but currently many boards of trustees are taking on asset allocation reviews post the financial crisis in an attempt to make up for lost time. Also, in many cases, they have tried to lower their actuarial return assumptions in the hopes of taking away some of the pressure.
Perhaps the final destination on this pension fund holiday should be the uncovering of what role alternative investments need to play and how larger allocations, to top performing hedge funds in particular, are funded.
In the early days of the hedge fund road trip, the new allocations (mainly to funds of hedge funds) were made at the expense of fixed-income portfolios - as hedge funds exhibited the same volatility as bonds. Then over the last decade or so there was a shift from equities to hedge funds as hedge fund returns looked similar or better than stocks. And, of course, portable alpha was very much about this shift in thinking.
Finally, the question posed by traditional consultants has been whether hedge funds are part of an alternative/opportunistic portfolio and funded from poor performing private equity allocations, or whether it is best to focus back on the fixed-income piece of the portfolio for future funding.
For a growing number of pensions, such as GE (see page 13) it's about strategically using hedge funds throughout the portfolio, and this looks like a model similar to those used successfully by university endowments until the liquidity crisis hit in 2008. And for groups such as the Florida State Board of Administration (see pages 14-16), relatively healthy actuarial funding has helped make the hedge fund question a little easier.
For those at the fork in the road, the ultimate formula is dependent on the likelihood of future contributions and the expectation of returns across asset classes as presented by traditional investment consultants. Once consultants are able to communicate the reality of this extended pension contribution holiday to trustees, the road leading to hedge funds becomes a little less bumpy.