Are pensions ready to play the redemption card?

Tue Jun 5, 2012

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Patience among trustees is waning. Funds of funds seem to be the early casualties, but single manager hedge funds are definitely not immune from scrutiny


By Susan Barreto

As we come up to the mid-year point for 2012, an increasing number of investors are beginning to wonder the same thing - are hedge funds a short-term gamble that are no longer worth the hassle?

It has been a hard pill for trustees and CIOs to swallow as the majority of hedge fund portfolios seem to still be in the red, having yet to bounce back from 2011 losses. The InvestHedge Composite index is up only 2.28% for the year-to-date up to the end of April.

This month we see investors reconsidering their past portfolio choices, and many are more willing to dabble with single managers in certain strategies aiming to boost returns and lower fees than were traditionally charged by funds of funds.

Funds of funds are squarely in the firing line. For instance, at Dorset Pension Fund in the UK, the plan is to conduct a full review this year of its funds of hedge funds (page 7). Gottex and IAM were highlighted as having performed below expectations: over the past three years, the double-leveraged Gottex fund produced annualised returns of 5.88%, while IAM generated annualised returns of 1.75%.

But over five years the industry's picture is better. Does this mean patience over the longer term or has the hedge fund tide turned for good? Trustees at the Avon Pension Fund (see page 6) are concerned over the returns of Man Investments, which recently struck a merger deal with FRM (page 29). With an absolute return of -5.8%, Man's bespoke portfolio is the worst-performing of the four funds of funds in the portfolio.

Direct hedge fund programmes are hardly immune from this underperformance trend. The California Public Employees' Retirement System hedge fund programme is still down for the year, with a loss of 1.5% for the year ended 31 March 2012 (page 7).

Meanwhile, Colorado Fire & Police Pension Association is looking to boost returns via single-manager hedge fund selection with the help of Albourne Partners (page 10). Funds of funds still play an active role in the portfolio, but for staffer Austin Cooley FoHFs in general have a very high standard to live up to justify their fees.

Some are giving up on hedge funds altogether this year. The $17 billion Philips Pensioenfond in the Netherlands has decided to withdraw from hedge funds as an asset class as part of a strategic reallocation (page 8), and if one only looks at the three-year picture from 2008, it is easy to see why.

Chronic underperformance is not only affecting pension trustees, but endowments are also struggling to justify their hedge fund programmes when this happens, as will be seen in more detail in next month's US endowment survey.

Fees are a big part of the roll of the dice. Trustees are wondering why they should pay more than a 1% management fee, when multi billion-dollar hedge funds now have the advantage of scale in running their business. Performance fees may not be applicable in this down market, but management fees can add up. In fact, a recent press report told of trustees of one large US public pension fund questioning $38 million in hedge fund fees being paid for a portfolio which sustained losses in 2011 and early 2012.

Patience among trustees is waning. Funds of funds seem to be the early casualties, but single-manager hedge funds are definitely not immune from scrutiny. The question is of course: when do you pull the trigger? If institutions fail to see a healthy gain over the cycle, how long will they be willing to pay up?

This may also ultimately affect the businesses of specialist consultants such as Albourne Partners, Aksia and Cliffwater. The stakes are high after all, as most pension funds are under water when it comes to long-term funding. But the stakes could be even higher for a segment of the asset management industry that has prided itself on separating its brand of alpha from long-only beta managers.

Whether or not the end of 2012 will spell the end of the hedge fund road as we know it all rides on the returns of the next few months.