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Dutch pension scheme turns to hedge funds


Date: Monday, August 24, 2009
Author: Suchita Nayar , Financial Times

These are difficult times for pension plans around the world; market tribulations in 2008 badly hurt their performance record, leaving many teetering and underfunded. Aggravating the trouble caused by plunging asset values, the steep decline in global interest rates has further escalated their liabilities.

Stichting Pensioenfonds ABP, the Netherlands-based pension sponsor servicing 2.7m Dutch education and government workers, did not avoid the rollercoaster. The plan, third largest in the world after the Japanese and Norwegian state pension funds, with €173bn (£149bn, $245bn) of assets, lost 20 per cent in value in 2008, severely denting its funding ratio and asset base. Liabilities, meanwhile, rose to €193bn from €155bn, triggering an ambitious five-year resuscitation plan. As of June, ABP’s recovery was ahead of schedule. Assets have risen to €180.5bn while liabilities have fallen to €185bn. The coverage ratio now stands at 98 per cent, compared with 90 per cent at the end of 2008.

Part of this recovery is due to increased exposure to hedge funds. Earlier this year, ABP raised its allocation to absolute return strategies by one percentage point even as hedge funds in general were reeling from the fallout of their worst ever year in terms of losses and redemptions. The average hedge fund fell 19 per cent last year and industry assets tumbled to $1,300bn from a June 2008 peak of $1,900bn.

The increased allocation to hedge funds looks like small change for the giant plan, but if it is successful the move could help steer ABP toward recovery. The Absolute Return Strategies division now takes up 6 per cent of its balance sheet, about €10bn. It comprise Amsterdam-based Global Tactical Asset Allocation (GTAA), a directional and liquid portfolio that seeks to exploit short-term market inefficiencies around the world; and New Holland Capital of New York, which invests in external alpha, or excess return-seeking hedge funds.

These strategies, and all the plan’s other portfolios, are managed by APG (All Pensions Group), its asset management and administration arm, voluntarily spun off by ABP in March 2008. ABP remains its sole owner.

Gerlof De Vrij, a managing director of Absolute Return Strategies and fund manager of GTAA, is helping oversee it all. Through GTAA, he oversees internal investments in managed futures and global macro strategies that can span anything from a few weeks to years, and also allocates to an array of external managers.

Thanks to its diversity, GTAA delivered gains in 2008 despite widespread losses in most of ABP’s other asset classes – commodities, equities, private equity and real estate. Fixed income, meanwhile, eked out a small gain. That said, the overall absolute return portfolio, including New Holland Capital’s investments, delivered a loss of 5.6 per cent. This year, GTAA’s performance has been “very good,” says Mr De Vrij.

“Hedge funds as an asset class have shown flexibility in the financial turmoil,” he says. APG is upbeat about this investment category.

“Our optimism stems from the fact that they give high returns with relatively low risk,” he says.

“It was last year’s liquidity scare that made hedge funds correlated to all other asset classes, but that’s not how things work fundamentally.”

The APG absolute return division tries to construct a portfolio with no correlation to bonds, currencies, equities or anything else, says Mr De Vrij. “We aim for absolute return and aren’t looking to benchmark our behaviour with other hedge funds or parts of the market.”

The real diversification comes from the fact that its investments can explore not only the liquid parts of the markets but also the more complex and non-traditional ones and can adapt rapidly to change in the marketplace.

Distressed assets still look attractive even though the peak investment period has passed, he argues. But he cautions that only long-term investors can benefit from illiquid strategies and only those who can stomach illiquidity should wade in.

Distressed or not, investors should view all hedge funds as an illiquid asset class, he says. “If you are going to view this asset class as a liquid one, you’ll use it as an ATM and that’s a mistake. If at the first sign of crisis investors take their money back, it won’t allow managers to exploit the complete market cycle,” says Mr De Vrij, who previously led strategy and research at PGGM Investments, another Dutch pension fund, joining ABP in August 2005.

He disagrees with those who hold hedge funds responsible for causing market upheaval. “Yes, speculators can destabilise markets, but if they were to sit on the sidelines, the total market liquidity will just dry up. In many cases, hedge funds have stabilised financial markets.”

However, some sort of regulatory checks-and-balances are warranted in the future. he feels, as self-policing by managers will be inadequate. The events of 2008 jolted investors’ confidence so deeply that it is unclear how quickly it may return. For now, “I feel the industry stress felt late last year is fading. Redemptions are becoming more manageable even though investors have become more risk averse in general.”

Hedge funds are making a range of attempts to regain investors’ trust. Some funds, especially those in distress, are offering better terms, says Mr De Vrij. Still, hedge funds with strong performance will continue to have the power to ask for unchanged fees even though investors these days clearly have an upper hand in negotiations, he adds.

One common misperception, according to Mr De Vrij, is that hedge funds are a risky asset class. “Hedge fund risks aren’t any different than those present in credit, real estate or other strategies as we saw last year when no single asset class was spared by the market turmoil; the fundamental link between hedge funds and other asset classes was the liquidity scare.”

On the performance side, hedge funds are now doing relatively well and will attract fresh capital if they can sustain the momentum, he predicts. The average hedge fund has returned about 7 per cent this year, according to industry estimates.

The question remains: When will investors return? Mr De Vrij reckons that in spite of the recent erosion of confidence, “quality investors” will find their way back into hedge funds. “The better part of hedge funds will survive,” he says. But they will have to resign themselves to more oversight. “We as investors want to see more transparency, risk reporting and proper due diligence processes. We want better checks and balances.”

Commenting on the noise surrounding various regulatory proposals on hedge funds, Mr De Vrij says “active communication” with rule makers is necessary. Being such a large investor in hedge funds, APG constantly engages the Dutch financial regulator in “an active conversation, to explain nuances of absolute return, how it works, why we’re comfortable with it, what risk-adjusted returns mean,” notes Mr De Vrij.