It’s shaping up to be a banner week for alpha-centric investing in Europe. No sooner had the ink dried on one landmark alpha-centric mandate (see yesterday’s posting about a $3b European 130/30 mandate), when another major European institution announced it would dump some of its funds of hedge funds and place its bets on “alternative beta” (a.k.a. hedge fund replication) instead.
One of Sweden’s public pension plans, the EUR9 billion AP7, announced the news at a conference yesterday. Reports IPE.com:
“Richard Grottheim, executive vice president of AP7, told delegates at the Pension Fund Investment World Nordic 2008 conference in Stockholm today the SEK 80bn (EUR8.6bn) fund had already reduced its allocation to hedge funds from 4% to 2% in 2007 because of ‘disappointing returns’ in the market.”
Grottheim told the gathering that he could get “the same returns” by investing directly in the risk factors that tended to drive hedge fund returns. (see previous posting on AP7’s alpha/beta separation programme)
But is this really the primary motivation for the move? Since hedge fund of funds returns are reported net of fees, it appears as though AP7 won’t be any better off after the shift. Granted, they won’t have to deal with the discomfort of making any fund of hedge fund managers rich (while they simultaneously aim to fund the retirements of hard working Swedes). But how does this shift really make life easier for the pension plan?
The answer may be more political than financial. As IPE.com reports:
“However, he pointed out the ‘most important reason’ was the ‘media risk’ associated with being a public investment entity with a high level of transparency, as the fund had previously invested in the hedge fund Amaranth – which collapsed in 2006. He said although AP7 can try to explain to the media why these are diversifying investments ‘it takes too much resources and energy’…”
This is a tangible example of the environment that likely motivated AIMA to speak out against excessive anti-hedge fund reporting in a recent press release (see related posting).
It’s also a notion expressed in somewhat less direct terms by the head of the UK Universities Superannuation Scheme (USS). Regular readers may recall that this pension plan gave a $200 million hedge fund replication mandate to State Street Global Advisors last month (see posting). According to HedgeWeek, the head of that plan also listed transparency as a key motivation behind the decision:
“We are convinced of the merits of hedge fund replication as a way of gaining transparent, liquid and low-cost exposure to the risk premia that drive the majority of hedge fund returns. We see this strategy as a core part of our approach to investing in hedge funds alongside our single manager hedge fund programme…”
Regular readers may also recall an institutional survey last year by consultancy Casey Quirk on the primary reasons why non-investors in hedge funds chose to avoid them (chart at right).
Number one on the list: “headline risk“. Last on the list: “returns“.
Merrill Lynch picked up on this theme and concluded in a research note late last year that hedge fund replication could be a potential “solution” for new hedge fund investors since it mitigated the dreaded headline risk (see related posting).
While they appear different on the surface, 130/30 and hedge fund replication share a lot in common from an institutional investor’s perspective. Both mitigate the extra-economic concerns uncovered by the Casey Quirk study.
For more on how the salient elements of both these products map to the interests of many institutional investors, we recommend these articles from the fall 2007 edition of the Canadian Investment Review:
- “Two Solitudes”, (By Tris Lett & Christopher Holt): “…Both of these emerging strategies address many of the hurdles that have stymied the adoption of hedge funds, mainly because neither of these strategy classes are truly hedge funds, but rather the adoption and modification by institutional investors of appealing features of hedge strategies.”
- “The Alpha/Beta Divide”, (By Prof. Andrew Lo): “…As institutional investors take a more active interest in alternative investments, a significant gap has emerged between the culture and expectations of those investors and hedge fund managers…This cultural gap raises the natural question of whether it is possible to obtain hedge fund-like returns without investing in hedge funds.”