“Do hedge funds make sense?” asks Jean-Marc Stenger, chief investment officer for alternative investments at Lyxor Asset Management speaking at the Fiduciary Investors Symposium at Oxford University’s Rhodes House.
Hedge fund assets may have reached a record $3 trillion in 2014 but the decision by a number of high profile pension funds to drop hedge funds from their allocation has sparked questions around the role of these funds going forward.
Although Stenger lists recent criticisms around the industry, including underperformed compared to all other asset classes since 2009, a risk perception, light regulation and, perhaps most importantly of all, the high fees still associated with hedge funds, he argues that over a long time frame hedge funds returns are “outstanding” and that structural and cyclical factors explain the problem.
Hedge funds are struggling in a low volatility environment where Central Banks have distorted asset prices with QE, he argues. Hedge funds have an important role around diversification including offering different investment styles and flexibility for investors. The regulatory framework is now robust enough for hedge funds to invest public money and transparency has increased. The industry is maturing; fees are falling, he argues.
High fees is one of the biggest bugbears at the BBC Pensions Trust, which manages £12.5 billion ($18.5 billion) of assets for the UK’s state broadcaster.
“Any alpha created is taken out with high fees,” argues Ajay Ahuja, pensions investment manager at the fund. “
We look at what skills they are delivering, and what our take should be on that given we are putting up risk capital,” he says. “It’s difficult but worthwhile. We look for sensible fees, high hurdle rates and an alignment of interest. We are seeing fees come down but it is still sticky.”
Fees are also an issue at USS Investment Management, argues speaker Kathryn Graham, head of strategy co-ordination at the at Universities Superannuation Scheme, USS, which operates one of the largest pension schemes in the UK, with total fund assets of more than £40 billion ($60 billion). “Returns have come down astronomically but fees haven’t. Hedge funds are never going to be a big allocation because we do quite a bit in house,” she says.
Nor do hedge funds always offer the kind of diversification investors seek, argues the BBC’s Ahuja. “Hedge funds can have high correlations,” he says, adding: “There are other, non-hedge fund ways to protect with more certainty like equity options or moving to cash. We use options in our schemes.”
Managing hedge funds also requires resources, he says. “Hedge funds make sense but don’t just diversify for sake of it. Hedge fund investing requires lots of governance, even if outsourced.”
For Magnus Eriksson, chief investment officer of the Fourth Swedish National Pension Fund, AP4, the main conflict within the fund’s hedge fund allocation is balancing hedge fund strategies with AP4’s commitment to long term investment.
“AP4 don’t invest in hedge funds unless they are completely transparent offering real-time access to their portfolios,” he says. The fund is also “fee sensitive” with investment costs for the entire fund kept to 10 basis points. Hedge funds work to a fixed fee based around this budget with “no leakage,” says Eriksson.