Addressing delegates at IRC’s Hedge Royale conference in London, he said that of the 14 council pension schemes that had hedge fund exposure, Avon had allocated the largest proportion. “So I implore the managers we’ve employed to do well – it will help us and it will help you with other local authority pension funds.”
The scheme invested 10 per cent of its assets in funds of hedge funds this year – 5 per cent with Man Investments, 3 per cent with Gottex and 2 per cent with Signet, with Stenham Advisors and Lyster Watson & Co selected as back-up. Things got off to a shaky start with a 2.1 per cent loss in August, but the portfolio recovered 2 per cent in September, and Mr Worth noted that the scheme received estimated valuations from the funds within 10 days and full commentaries within a month.
The valuation of March 2004 had revealed poor performance from the scheme’s active managers. It was felt that the most talented managers had moved into the hedge fund arena and this, alongside a “positive steer” from the scheme’s consultant, PSolve, led to serious discussions of absolute return funds as the ALM study kicked off in November 2005.
“Trustees had to undertake a major education programme,” said Mr Worth. “We looked at the historical performance of hedge funds, and we found it quite compelling – 10.9 per cent before fund of fund fees. But what we thought we would achieve with the allocation was not so much improved performance, purely, but improved volatility. You could say we expected the investment to move the efficient frontier.”
As such, the scheme looked for a diversified allocation, and claims that it has achieved average volatility of 3.9 per cent across its hedge funds. The volatility of the pension fund as a whole has been reduced from 10.5 to 9.0 per cent while performance has remained steady at gilts plus 2.4% per cent, according to Mr Worth.
A new scheme benchmark was agreed in September 2006, which saw asset allocation move from 75 per cent equities and 25 per cent bonds to 60 per cent equities, 20 per cent bonds, 10 per cent property and 10 per cent funds of hedge funds. The fund of funds mandate was advertised in October 2006.
The scheme employed bfinance for the manager selection process, and 84 tenders were received. Bfinance’s quantitative screening reduced that to 35, and qualitative screening reduced that again to 19. At that point the Avon Pension Fund took over and reduced that to a longlist of eight.
“Usually members of the investment committee interview and select managers, but when it came to funds of hedge funds we decided that this had to be done by the investment staff at the scheme because of the complexity of the issues involved, leaving the formal selection decision to the committee,” said Mr Worth.
Mr Worth was asked about how detailed the scheme’s due diligence was with reference to underlying hedge fund strategies in the funds of funds, and whether he had any advice for pension funds considering an allocation.
“Perhaps we should have asked more about the gearing on the underlying funds,” he said. “We asked about gearing at the fund of funds level, but it would have been better to find out more about what is going on underneath. All the funds of funds we looked at had very sophisticated risk management systems in place – we ourselves were not able to go down to that level of detail. But otherwise we wouldn’t change what we did during the process.”
MS
