ANALYSIS

A spotlight on hedge funds

A story we published  on hedge fund portfolios questions whether they are worth it for large institutional investors. Analysis of more than 400 institutional investors’ hedge fund portfolios showed they do not deliver on their promise of added return or risk mitigation and could be replicated at much lower cost by simple debt/equity blends, the research by CEM Benchmarking has found. Many hedge fund portfolios perform well before costs but fall into negative alpha due in large part to the hefty fees paid to service providers. 

Many leading funds, such as the $71.9 billion Massachusetts Pension Reserves Investment Management Board, have been addressing this issue of costs. Mass PRIM called in executives at one of its longest-serving and most skilful hedge fund managers for a chat. The pension fund’s analysis of all its active managers involves factor and return decomposition, in which performance is broken down to see if it is attributable to factors or other persistent biases or tilts. The Boston-based fund staunchly pays active management fees only when strategies show true skill and can’t be replicated or bought cheaper elsewhere. Alarm bells rang when the returns from the hedge fund in question tallied closely with returns gained through a two-year exposure to US Treasuries.

“The manager ran a long-short equity fund; it wasn’t being paid to buy bonds,” chief investment officer Michael Trotsky says with a wry laugh.

Meanwhile, Canada’s C$95 billion ($74 billion) AIMCo, already renowned for its willingness to experiment and an eclectic mix of assets that includes a Chilean utility and BBC Television Centre in London, is pushing innovation further. It’s taking ownership stakes in energy groups and hedge funds, using new technology to boost efficiency, and going after private equity with renewed gusto.

Across the Atlantic, AP3, the SEK345.2 billion ($42.2 billion) Third Swedish National Pension Fund, scaled back on hedge funds last year, and boosted its internal portfolio construction capabilities. It introducedvolatility risk premium back in 2010 and has since added other premia, such as value, quality, momentum and carry, all designed and run by external managers until recently. It has now internalised all construction of the risk-premia portfolio. Also in Europe, the sophisticated Danish ATP posted an annual return of 29.5 per cent, driven by its return-seeking portfolio, which makes up about one-seventh of the fund.

It has been run on a risk-parity basis since 2005, and ATP recently decided to replace the traditional asset classes it had invested in during the last 10 years with allocations based on equity, interest rates, inflation and other risk factors – namely illiquidity and an allocation to long/short hedge funds or alternative risk premia.