In the UK for instance, many pension funds which were 80 per cent invested in equities at the turn of the millennium, have now reduced that weighting to 60 per cent, while increasing their allocations to other asset classes.
Private sector pension funds, in particular, have been gradually de-risking their portfolios by moving money out of equities in order to increase their allocations to bonds. Fixed income portfolios still tend to be made up of UK government bonds and investment-grade corporate bonds, with only limited exposure to high yield debt or emerging market debt.
According to John Hastings, a partner in the investment practice at consultants, Hymans Robertson, only 1 or 2 per cent of an aggressive bond mandate might have been invested in CLOs or CDOs, an exposure whose impact on the bottom line of a fund would be “almost invisible”.
Data from the UK’s National Association of Pension Funds shows that only 10 per cent of members have invested directly in hedge funds. A larger number have invested in funds of hedge funds so avoiding over-exposure to a single strategy such as ABS CDOs. This could be good news for fund of hedge fund managers which have suffered much bad press on account of high fees and mediocre returns. Managers of property and private equity funds of funds might also happily anticipate increased subscriptions from pension schemes. One might not amass great riches with a well-diversified portfolio, but the chances of going broke are certainly reduced.
Of course, investors tend to look at the benefits of diversification when markets are falling. But when markets are rising, the focus switches to the cost of diversification which is usually the limitation of upside - the price of removing some downside risk.
Pension funds are further widening their asset base by investing in so-called diversified growth strategies as run by investment houses such as Schroders, Fidelity, Barings and Credit Suisse.
Typically, such strategies consist of a 40 per cent investment in traditional equities and a mix of other asset classes, including high yield bonds, private equity, hedge funds, property and commodities.
Despite the falls in equity markets and bond yields since the end of June, UK pension fund investors are still slightly better off than they were at the start of the year, according to John Finch, investment consultancy director at HSBC Actuaries and Consultants. The FTSE All-Share index was up about 1 per cent from the end of 2006 to 10 September, while UK government bond yields were about 20 basis points higher.
Pension schemes, being long-term investors, should hopefully recover losses arising from the on-going volatility in the equity markets. In the short-term, it’ll be a queasy ride for trustees of a nervous disposition.
What are you are getting into?
Should hedge funds be regulated? In the aftermath of the headline-making losses suffered by some of the biggest names in the business, many believe they should be.
Charlie McCreevy, European Commissioner for Internal Market and Services, an implacable opponent of market intervention, has once again made it clear that he is against the idea of circumscribing the activities of hedge funds.
While acknowledging that hedge funds and the institutions who invested in them may have suffered heavy losses, he recently resisted calls to send in the regulators.
In an address to the European Parliament this month, he said: “Financial markets function on risk. I do not criticise those who make fortunes when times are good. I’m not going to shed any tears now if there are losses.”
Few in the financial services arena would argue with that sentiment since hedge funds are generally the preserve of sophisticated investors who should know what they are getting into.
But do they? Transparency, or the lack of it, is a live issue and it is arguable whether institutions knew about or fully understood the risks inherent in the complex strategies they were investing in. If those hedge funds that lost money or saw their strategies rendered worthless, failed to anticipate the looming subprime crisis, how could a pension fund or investment consultant, for that matter, be expected to know any better?
Although it can be argued that institutions which invest in funds of hedge funds are afforded a degree of protection through diversification,
it is not inconceivable that large, well-resourced pension funds such as the California Public Employees Retirement System or The Netherlands’ ABP, could fall foul of the opaque nature of the hedge fund world.
The regulation of hedge funds might not happen soon, but it is sure to happen eventually.
Henry Smith, editor
henry.smith@ft.com
