22/09/2010 Author: Shannon Hawthorne

Happy families

The challenge of securing investment from institutional investors is one that has risen up the list of hedge fund priorities in recent years. With many still unconvinced of the benefits of alternatives, HFMWeek offers you a handy guide to trustee types 

The hedge fund industry is filled with large firms investing large amounts of money while trying to attract large investors – and yet the fact remains: it’s the details that matter. That small change in fees, that miniscule dip in the value of an underlying asset, that almost-unnoticeable

miscalculation of a fund’s Nav – these are the things that can mean the difference between success and failure for a hedge fund manager.

So when research figures show that around a third of institutional investors are looking to increase their hedge fund allocations over the next 12 months, as encouraging as the big picture may be, it’s important to look beyond the statistics and trying to understand, on a granular level, what is driving these trends – and that means considering who within these institutions is ultimately responsible for deciding whether or not to invest into the hedge fund space.

 For pension funds, this role is usually held by the trustees – around six to ten individuals, on average, whose investment experience can be anything from ‘I worked in an investment management firm for 15 years’ to ‘I occasionally skim the FT’.

 And while there’s no denying the role that consultants continue to play in investment decisions, ultimately, it’s the trustees who have the all-important voting rights, and so it’s the trustees that managers have to win round if they are to secure that much-sought after allocation.

 “Many hedge fund managers fail to win institutional business because of a lack of understanding of how a pension fund determines its investment strategy, the role of trustees and their decision-making process,” says Gihan
Ismail, who leads the services to asset managers business at PiRho Investment Consulting.

 Yes, pension funds who already allocate to hedge funds may be looking to increase allocations, but for those yet to make an investment, the sector can still seem confusing, intimidating and ultimately, unappealing.

 As previously reported in this magazine, out of 60 public and private UK pension funds, polled as part of an ongoing HFMWeek survey, only 11% not currently investing in hedge funds described their trustees’ attitudes towards the sector as ‘positive’, with the majority classifying their stance as either ‘negative’ (37%) or ‘wary / uncertain’ (25.9%).

 So while the concept of a more institutional hedge fund market is fasting becoming a reality, managers still need to make the effort to truly understand these institutional investors, and in the case of pension funds, this means
understanding the trustees.

And it’s with this in mind that HFMWeek has identified the key trustee board members  and examined their role on the board, their professional backgrounds, and most importantly, how all of these facts might impact their decision to say ‘yay’ or ‘nay’ to investing in hedge funds.

THE MEMBER-NOMINATED TRUSTEE
Member – or employee – nominated trustees (MNTs) – trustees who have been voted in by the pension scheme’s members – normally make up a sizeable proportion of a trustee board (in the UK, MNTs are required to make up at least a third of a board’s membership). These trustees are typically either current or former employees of the company in question and so, can come from any number of professional backgrounds.

It’s perhaps too easy to discount MNTs as simply people ‘from the shop floor’ whose lack of investment experience means that they’re unlikely to be able to make a meaningful contribution to the board. The opposite is, in fact, often true.

“I’ve heard from many investment experts that it’s the questions from the inexperienced that have opened the minds of the experienced to new ideas, because they are looking at it from an angle that a seasoned professional may not have considered,” said Donald Kendig, a trustee at the $1.65bn Santa Barbara County Employees' Retirement System (SBCERS).

Interestingly, the nature of the respective industries in which the MNTs work can impact upon their investment views, something prospective hedge fund managers would do well to take into account. “People who work for a scientific company might think in a much more logical way, and may not understand uncertainty in the same way an investment manager does because they want certainty,” one large FoHF manager told HFMWeek. “Or, another example, people who work for a firm that represents airline staff and pilots are normally very risk averse.”

THE PROFESSIONAL TRUSTEE
Boasting knowledge, experience and, importantly, impartiality, the appeal of professional independent trustees is obvious. Such trustees can assist a pension board in numerous ways, ensuring they receive proper advice from investment advisors, and asking probing, in-depth questions, all the while remaining completely objective – or at least, that’s the idea.

However, the expectations facing independent trustees do not always match the reality, and for a pension plan considering allocating to hedge funds, relying on the expertise of a professional trustee to make their decisions may not necessarily be the best course of action. In the same way, hedge fund managers should perhaps shy away from assuming that a professional trustee will have a more in-depth understanding of the sector than their less-experienced counterparts.

“While professional trustees can bring a substantial level of experience and expertise in many areas, this can also be accompanied by pre-determined views of how things should be done, and they aren’t necessarily experts in all of the complex issues and areas of investment that many pension funds now have to deal with,” says Gihan Ismail of PiRho. “It may often be harder for professional trustees who do come with some experience and knowledge of the financial world to actually admit that, much more so than a lay person.”

THE CHAIRMAN
The role of chairman is pivotal to the successful functioning of a trustee board, according to Nicola Ralston, director of PiRho Investment Consulting. “A good chairman is somebody with a sufficiently open-minded attitude and willingness to seek advice, and the ability to recognise the knowledge that different trustees bring in order to reach decisions and achieve consensus.” says Ralston.

“If you don’t have the right chairman in terms of the combination of personal skills, knowledge and ability to get the right people on the trustee board, it’s often very difficult to achieve a satisfactory outcome, regardless of the strengths of the rest of the trustee board.”

While the chairman has historically come from within the company in question, often from a position of finance director or retired board director, pension funds are now increasingly looking to external independent chairmen, and importantly, ones with relevant experience.

“These are often, though not always, people from the investment management industry or the financial industry in general,” say Ralston.

THE LOCAL POLITICIAN
Local politicians or councillors often feature on public pension boards, though not necessarily under the title of trustee. In UK local authority pension funds, assets are not held in trust, but are council assets, and as such, “members of pension committees in local government schemes are not trustees, but act in a fiduciary role,” explains John Hastings, a partner at Hymans Robertson.

With such members often accounting for a large proportion of public pension fund boards, hedge funds trying to attract investment from such schemes would do well to familiarise themselves with the political stance of those on the board as part of their research into the pension fund in question.

It’s also worth baring in mind that these board members are liable to change come election time, which may impact upon whether or not the pension ultimately invests in hedge funds. The London Borough of Camden Pension Fund, which HFMWeek recently revealed had confirmed plans to invest in hedge funds as part of a new 10% allocation to alternatives, originally delayed the decision until after the May UK local council elections to allow for the appointment of new board members.

This mutability of board composition can, in some instances, be beneficial to hedge funds: a public fund that was averse to allocating to hedge funds in the past may take a different view following a change in political membership.

THE EMPLOYER-NOMINATED TRUSTEE
“Historically, in the case of employer-nominated trustees, the trustee board has ended up with whoever the company has told: ‘It’s part of your job, go and sit on the trustee board,’” says Rachel Brougham, a principal at Mercer. “But today, we’re starting to see trustee boards actually approaching the company or sponsor and asking for nominees with skills in a particular area, be this investment or communication or whatever else.”

Indeed, trustee boards are starting to take a more prominent role in the selection of employer-nominated trustees, to ensure they are given people with the appropriate skills.

However, with employer- or sponsor-nominated trustees tending to be senior figures at their respective companies, time-management has also been an issue in the past. “As these employer-nominated trustees often have very busy jobs, they quite often struggle with the time commitment,” said Brougham. “As such, trustee boards are starting to think ‘Yes, we need senior people, but senior people who can commit to a role that’s becoming increasing demanding.’”