30/06/2010 Author: Shannon Hawthorne

The learning curve

With a record number of UK pension funds receiving hedge fund education, HFMWeek discovers how a greater understanding of the alternatives industry can often result in allocations

Last month, when the Montana Board of Investment voted unanimously against investing into the hedge fund space, the reasons given for the decision were almost predictable – concerns about high fees, unease about the perceived lack of transparency – and, as board member Teresa Cohea stated, the fact that “you don’t invest in what you don’t understand”.

Therein lies the problem. Lack of understanding, combined with a continued demonisation of the industry in the wake of the financial crisis and the Madoff scandal, has meant that, for some pension funds at least, the hedge fund sector remains a no-go area.

Even those institutions who do allocate to the space are often wary of publicly announcing the fact, with many referring to said investment as ‘absolute return’  in annual reports, and only revealing that it is, in fact, an allocation to hedge funds in a clandestine footnote.

However, improved performance and increased focus on transparency and operational due diligence has meant the tide is turning – albeit slowly – for the hedge fund industry, and institutional investors are beginning to show a growing interest in the space as they seek to diversify portfolios.

Last week, HFMWeek revealed that there had been a significant spike in UK pension funds receiving education about the space. Today, according to data compiled by the magazine, we can exclusively reveal that over 80% of UK pension funds are currently receiving education on hedge fund allocations, either specific to the sector or as part of overall investment training.

Training which Guy Saintfiet, senior hedge fund researcher at Hewitt Associates, feels is likely to translate into increased allocations. “Pension funds are often  uncomfortable about the idea of investing in hedge funds prior to training sessions,” he says. “However, once they feel they have a better level of understanding and realise the benefits, they frequently ask us if they shouldn’t allocate a greater proportion of their overall portfolio than we initially suggested.”

However, James Lewis, head of Europe at Albourne Partners, remains unconvinced that pension funds’ desire for hedge fund training is necessarily a new phenomenon, although he acknowledges that there has been an increase in actual allocations to the space.

“[Training] is something that we at Albourne have provided for many years,” he says. “It’s not that pension funds are all of a sudden deciding that they need to receive hedge fund training; rather, more often these training sessions are requested by investment staff, and are designed to provide comfort to trustees that an allocation to hedge funds is
appropriate and address some of the myths that surround the industry.”

Irrefutable, however, is the growing desire from hedge funds – and funds of hedge funds (FoHFs) – to attract long-term, stable investments from institutional investors – so-called ‘sticky money’.

And with the understanding that education is likely to be the best way to attract institutional assets, and to retain existing allocations, many hedge funds are now taking the first step in reaching out to pension funds.
“What’s more, they have realised that they need to present what it is that they do in a language that is more adapted to the pension fund community in terms of diversification benefits, sophistication of investment approach and risk management,” says Alex Pigault, director of research at Allenbridge Group.

Indeed, levels of understanding differ greatly from pension fund to pension fund, with the most evident disparity of knowledge between US and European funds.

“In the US, they have progressed to the stage of asking ‘How can we best allocate across hedge fund strategies?’, compared to Europe, where pension funds are still at the stage of asking, ‘Do hedge funds actually benefit an investment portfolio?’”  says Pigault.

As such, effective training, whether delivered via a consultant or by the hedge fund itself, often involves going back to basics.

“The most widespread misunderstanding about hedge funds is that they are a single asset class,” says Saintfiet.  “One of the key things that the training that we at Hewitt provide explains is that they are in fact a set of strategies, and that there are not only huge differences between those strategies, but also between various managers, with regard to track record, level of regulation and risk oversight, to name but a few.”

“Hedge funds, therefore, for their part, need to be able to explain to institutions both how their strategy works and how their firm operates as part of their pension fund training,” he continues. “That’s the only way forward if they want to attract more institutional money.”