Pension funds shun gold and hedge funds

Due to the low return from fixed income, pension funds need to look to alternative asset classes to supplement returns.

Allocation to equities has fallen from 85% in 1992 to 45% today, and allocation to fixed income has increased from under 10% in 1989 to close to 40% today. But the fall in real government bond yields is damaging funding calculations for pension plans.

In a paper on pension fund strategy published last week, entitled "What are pension funds doing?," UBS Investment Research and Jeremy Dell, pension consultant with Lane, Clark and Peacock, said pension funds require a real return of 3-4%. But with bonds yielding 0.06%, pension funds are being forced to look for alternatives.

According to the report, Dell spent a few weeks in meetings with some of the largest FTSE100-sponsored pension plans discussing asset allocation and risk management.

The results of the conversation show pension funds are avoiding gold, hedge funds, private equity and ETFs. Despite the rally in gold prices, reaching a record high in September, the precious metal is a store of value, and does not provide any income.

The report also noted that pension fund trustees have fallen out of interest with hedge funds, and the fees charges do not justify the performance or protection offered by the asset class.

Private equity is being dismissed due to its illiquid nature, and ETFs have not been used extensively by pension funds.

Pension funds are now considering investing or increasing their allocation in developing world equities, emerging market multi-asset funds, diversified absolute return funds and swaps.

On Monday, Financial News highlighted that some investors were moving from hedge funds to absolute return funds. Helena Morrissey, chief executive of Newton Investment Management, a mainstream asset manager, said: “Clients are quite quiet about where their money is coming from, but it is our understanding that some of it is coming from ex-hedge fund mandates. We have certainly described what we do around absolute return as an alternative to alternatives.”

Not everybody agrees that pension funds should be avoiding hedge funds as a means of boosting returns. Last month, Dr Everett Ehrlich, a business economist at Washington-based consultancy ESC Company, who was previously the under secretary of commerce for economic affairs in the Clinton administration, said university endowments would also benefit from moving assets to hedge funds.

According to Ehrlich, investing in hedge funds could boost returns by $13.67bn a year if they reallocate 10% of their portfolios to the funds, according to a new research paper.

Some alternative investment funds are unlikely to decrease their fees to meet the demands of pension funds. According to a survey from Prequin last month, infrastructure fund managers are sticking fast to their high private-equity style fees.