Take a couple of recent surveys into the use of derivatives by UK pension funds. According to consultants Watson Wyatt, demand for such instruments continues to grow rapidly, fuelling the inflation-linked market which is expected to double in 2006.
The size of the UK market in 2005 for end-users (excluding intra-bank trades and execution with insurers) was estimated by a number of banks at around £9bn (€12.9bn), but based on the size of inflation-linked swap executions Watson Wyatt said it had already completed this year, the market could exceed £20bn by year end.
Contrast the findings of that report with another produced by Mercer Human Resource Consulting in conjunction with the Association of Corporate Treasurers. It reveals that interest-rate and inflation derivatives are being used by just 6 per cent and 4 per cent respectively of FTSE 350 companies, while none are using derivatives to hedge against credit risk.
So who are investors to believe? And these are reports published by two of the world’s leading investment consultants. Every day of the week, investors are being bombarded with the latest investment research from asset managers, which often acts as an underpinning for a product plug. Such papers need to be viewed with a critical eye.
For instance, a recent release issued by F&C Asset Management (and presumably circulated to its clients) claimed that at times of high volatility, a portfolio of hedge funds offers the best risk/return profile. While it is true that hedge funds can prosper during times of heightened market volatility, one might ask if it is not equally or more valid to take advantage of volatile and falling stockmarkets by buying a lot of equities on the cheap and waiting for them to rise in value again?
Then there are the reports which are designed to educate and illuminate, but which can end up confusing the ill-informed or inexperienced investor, if read in conjunction with other studies on the same subject.
For instance, Mercer Investment Consulting published a report last month, which warned investors that they could lose money by following the traditional passive futures approach to commodities investment, even if prices remained stable.
If the report is compared with another piece of research into commodities investing, the potential for confusion becomes clear. A study by Ibbotson Associates for fund manager, Pimco, reveals that commodities improve portfolio efficiency and returns when part of a strategic asset allocation. To assess how commodities would have contributed to risk-adjusted returns in a strategic asset allocation alongside stocks, bonds and cash, the study analysed the role of commodities as represented by a composite of four commodity indices based on annual data from 1970 to 2004. The report concludes by saying that commodities will continue to produce equity-like returns and that current strategic allocations to commodities are too low.
For the last four years, hedge funds have been the subject of a huge number of reports, surveys, and conference presentations, reflecting the tireless efforts of alternative investment managers to attract greater amounts of institutional money into their products.
However, when it comes to the UK at least, hedge fund managers have little to show for their marketing work. A recent survey of 574 European pension funds, conducted by Mercer Investment Consulting, found that 7 per cent of UK pension schemes invest in hedge funds, compared with 13 per cent in continental Europe.
During an interview with FT Mandate at the recent Fund Forum conference in Monaco, Bob Parker, vice-chairman of Credit Suisse Asset Management (CSAM) acknowledged that asset managers were frustrated at the slow take-up of hedge funds by institutional investors. He said this was partly because investors were still unclear about the issues of transparency and risk management. Also, they were undecided on the merits of single strategies versus funds of hedge funds.
Paul Niven, head of asset allocation at F&C, said (in the above-mentioned report) that in light of current pension fund deficits in the UK, “it is puzzling why UK schemes are still so hesitant to make full use of hedge funds in their asset allocation”. He claimed that the historic risk of losing money is lower with hedge funds than with equity.
Asset managers and consultants are agreed on the need for more investor education in order to boost demand for alternative investments.
But Mr Parker did not want to be too critical of UK pension fund trustees who he said are concerned not only about their deficits but about the personal liability attending their position.
He said: “If you are worried about that, you tend to be more conservative rather than open to new ideas.”
He also argued that the UK pension fund industry was not resistant to change, it had simply been hit by so many negative factors in the last four years that the decision-making process had become slower than it might otherwise be.
Henry Smith, editor,
henry.smith@ft.com
