Pension schemes seek to create own fund of funds

Date: Friday, July 24, 2009
Author: Cecilia Valente, Reuters

Pension schemes are increasingly rejecting pre-selected fund of funds in favour of creating their own portfolios, as they look for direct control over their investments, said a senior investment consultant at Mercer.

Tom Geraghty, business head of investment consulting for Europe, the Middle East and Africa, said institutional investors were scouting for single hedge fund strategies after a year in which fund-of-fund losses have cast doubt on manager skill.

"If anything the approach to investing in hedge funds going forward will be multi-strategy as opposed to a broad collection of hedge funds," he told Reuters.

He said long/short funds and distressed debt products were attracting particular interest.

There has already been evidence that pension funds did not lose faith with hedge funds through the credit crisis, but Geraghty's comments suggest a clear change in emphasis.,

Over the last decade, the pensions sector turned to alternative asset classes, often using funds of funds to access private equity and hedge funds, while also adding real estate, commodities and derivatives exposure to spread risk and enhance returns.

Funds of funds last year lost 21 percent on average, according to data providers Hedge Fund Research, in a tumultuous year marked by some players' exposure to the Madoff scandal.

DE-RISKING

Geraghty said pension funds are still seeking to de-risk their portfolios but will only make a concerted effort to cut equities exposure, particularly in domestic markets, once markets rally enough to cover the last year's losses.

Geraghty said the change in mood brought about by the shock of the credit crisis has also pushed pension fund trustees to seek greater expertise and a higher degree of accountability in both their fund managers and consultants.

As a result, Geraghty said he expects Mercer's fiduciary business -- which gives consultants far more control -- to grow by up to four times in the next three years, accounting for as much as 20 percent of the global business.

"That goes with the fundamental changes around risk management and governance," he said.

Fiduciary management sees consultants take direct responsibility for allocation and investment decisions within parameters agreed in advance with the pension scheme. Under a standard arrangement, the consultant would advise the scheme on issues including the hiring of fund managers.

The fiduciary model has been pioneered in the Netherlands since the turn of the century and has also seen fund managers take on fiduciary roles.

"Unrewarded risk is off the table. (Investors) accept and acknowledge increasingly that it is about making the right asset allocation decision as opposed to the manager you pick," Geraghty said. He said fund managers and consultants must adapt.

"The survivors will be the ones who can have a partnership conversation with clients; more in depth analysis about how they have composed their portfolios, why they have outperformed and underperformed, what are the risk management processes."