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Hedgeweek Special Report: Pensions across Europe warm to hedge funds as institutional allocations continue to grow

Some of the biggest European pensions including those run by Nestle, Electrolux, BT, Railpen Investments and a number of UK councils, are making significant allocations to hedge funds.

Nestle scheme, one of Switzerland's biggest pension funds with SFr6.2bn (GBP 1.1 billion) is investing 18% in hedge funds. The investment, amounting to more than SFr1 billion, is one of the largest allocations of assets to hedge funds by a European pension fund.

The Nestle scheme, which has 13,300 contributors and pensioners, boosted its allocation from less than 1% in 1996 to a strategic weighting of 5% this year.

Nestle, which hires external fund of hedge funds specialists, has used Unigestion, a Geneva-based group, since 1997. It has recently hired two other firms: Grosvenor Capital Management, based in Chicago, and Union Bancaire Privee Asset Management, a New York-based subsidiary of the Geneva bank.

Electrolux AB, the world's largest maker of home appliances, has also invested some of its Swedish pension assets in hedge funds to boost returns.

The Stockholm-based company has put "between 5-10% of the 1.2 billion Swedish-krona (USD 155 million) pension fund into hedge funds. Spokesman, Jacob Broberg, said a team from Electrolux will visit the US this week to look at investing a similar portion of its US retirement assets in hedge funds.

According to a report by Morgan Stanley, one in six continental European pension plans invests in hedge funds, compared with one in 50 in the UK.

But there are signs that the situation is changing in the UK where a number of key pension schemes are allocating to hedge funds.

For example, Railpen Investments, RT Group's pension fund which includes the British Railways and the British Transport Police superannuation funds, is planning to invest over GBP 600 million  or 5% of its assets in hedge funds.

Chris Hitchen, Railpen's chief investment officer, advised the move as part of a diversification strategy. Railpen, which controls about GBP 13.6 billion in assets, intends to invest in a fund of hedge funds and only a couple of Railpen's nine pension schemes will not invest in hedge funds.

Last week Clwyd Pension Fund announced it was allocating to funds of hedge funds. The lead authority for the Clwyd Pension Fund, Flintshire County Council, is the latest in a growing number of UK Counties allocating pension fund assets to alternative investments.

Dorset County Council has also revealed it is looking for fund of hedge fund managers to invest GBP 45 million - or 5% of its scheme.

Flintshire County Council, which administers the GBP 550 million Clwyd scheme, has appointed fund of hedge fund managers Quellos and Pioneer to run GBP 11m each. This brings Clwyd's exposure to hedge funds to 17% of its total scheme assets with Barclays Global Investors running a GBP 50 million market neutral fund and an GBP 11 million currency hedge fund run by Goldman Sachs Asset Management and Gartmore.

This level of exposure is higher than average in the UK and is set to rise.

Nigel Meir, Pioneer Investments' Head of Sales and Distribution for the UK, welcomed the allocation: "We have only recently begun talking to the UK institutional market.  UK institutions are among the most demanding investors in the world and we had very strong competition.  It is extremely encouraging for our business development plans that we have secured this mandate win so soon after entering this market."

A spokesperson on behalf of Flintshire County Council gave some clues as to what it was looking for in a fund of funds manager, noting: "In this highly specialist area, we selected Pioneer Alternative Investments for the strength of their process, their performance record and the stability of the investment team."

Pioneer's Nigel Meir observed: "AllWeather has the type of track record that is encouraging growing interest from institutions. However, we appreciate that they must be satisfied, not only with the investment track record but also the strength of the covenant and the robustness of the process.  This win demonstrates that we have been able to address these issues."

Meir continued: "The case for allocating to funds of hedge funds is powerful if the credentials are right: they can bring good diversification to a portfolio.   I am confident that as more fund of hedge funds mandates are considered, we are well placed to be a serious player in that market."

The Clywd Pension Fund  mandate will be based on the flagship Momentum AllWeather Fund, one of the longest established low volatility funds of hedge funds - a risk-return profile which is proving popular with investing institutions that are new to the asset class.  It has delivered an annualised return of 9.3% with volatility of 3.3% since first established in 1995.

Shropshire and BT pension schemes also move into hedge funds

At the end of last month, Shropshire County Council in the UK allocated GBP 61 million representing 10 per cent of assets from its pension fund to two hedge fund managers, Man Investments and Quellos Group LLC.

And the BT (British Telecom) pension scheme, one of Europe's largest corporate funds and the largest in the UK with GBP 26 billion of assets, announced it is investing in hedge funds for the first time in a move that will sharply boost interest among other pension funds in alternative investments.

The BT pension fund trustees led by Sir Tim Chessells, a former director of Dixons, the high street electrical goods group, have given the go-ahead to a GBP 500 million investment in up to 40 hedge funds.

The allocations will make the BT scheme the single biggest pension fund investor in hedge funds in the UK.

Hermes, the scheme's adviser and fund manager, is to manage BT's hedge fund portfolio, assisted by UK-based Albourne Partners, the specialist hedge fund advisory firm.

The Shropshire County Council manages a GBP 610 million pension fund on behalf of employees of the County, District, Unitary Councils, and other admitted bodies.

The Shropshire mandates, which jointly constitute 10% of its pension fund's asset, were awarded to Man Investments and Quellos Group, LLC.

Phil Guy, the Council's Treasury & Pensions Manager said: "Man Investments and Quellos are good complementary managers, and provide additional diversification to our investment structure. Although the Shropshire Fund is one  of the best funded local authority schemes, this further reduces the risk of  deterioration in our funding level from market falls."

Scandinavian pension head calls for hedge fund  transparency

Although pension schems schemes across Europe are warming to hedge funds, the head of fixed income and alternative investments of the Euro 15.3 billion Andra AP-fonden (AP2) has sounded a note of caution, calling for a more transparent hedge fund framework.

Delivering an address at a seminar in Stockholm, Ole Petter Langeland said: "Any development towards a more transparent regulatory framework and growth of EU-domiciled funds is of great importance for AP2 as an investor in hedge funds."

Langeland said AP2 had allocated one percent to hedge funds but was not yet fully invested. The fund has more severe restrictions in investing, and has a ceiling of five percent in non-listed securities. Its current allocation to hedge funds is one percent. Real estate is one percent and real estate is three percent.

Langeland also said that because of the time-consuming work involved in hedge fund investing AP2 had chosen the route of hedge fund-of-funds.

AP2 returned 17.7% on total assets in 2003 - but underperformed its benchmark by 0.8%.

Sjunde AP-fonden (AP7) executive vice president Richard Gröttheim told the meeting that there is a broad range of alternative products available that fulfil institutional needs.

But he also pointed out that institutions need more flexibility. He added: "Issues to deal with are for example listing, liquidity, transparency, SRI and valuation." Gröttheim and Langeland said there are specific issues concerned for public entities such as special legal constrictions and socially responsible and corporate governance issues.

Gröttheim told delegates that AP7 has a full exposure to alternative investments. It can hold up to 10% of its assets in unlisted securities.

He said that the AP7 experience in alternative investments has been a complement to the overall portfolio with a low correlation to other asset classes.

And he added that the AP7 portfolio of hedge fund-of-funds and private equity fund-of-funds in combination has given the expected risk and return since implementation.

Gröttheim saw institutional interest in alternatives rising in the next few years.

The average allocation to alternative investments in Sweden is two percent. The general opinion among delegates at the seminar was that the allocation towards alternative investments could rise to  the region of 10%.

Germany takes steady approach to hedge funds

Despite media reports to the contrary, progress towards growing hedge fund allocations is slow and steady in Germany, rather than 'booming' as some reports would have us believe.

Only a year ago, many German institutions had no exposure to hedge funds.
Michael Busack, co-chairman of the BAI alternative investment association, said: "Insurers and pension funds have their backs to the wall because they've ignored alternative asset classes."

But that is starting to change. Hedge fund managers admit that, on average, German investors still have less than 2 per cent of their assets allocated to hedge funds. However, there are reports of some pension experts seeking to slash equities exposure and push hedge fund allocations up to 10, 20 or even 30 per cent.

Man Investments expects another change of gear in the second half of the year as insurers begin diversifying into hedge funds.

"The legislation has given an official seal of approval to hedge funds as an asset class," said Christoph Moeller, head of sales and marketing at Man, adding: "Insurers were blocked out of the market in 2003 because the regulator said hedge funds of funds didn't qualify as eligible capital for policy reserves. There is a lot of pent-up demand."

But some question how fast money will switch in practice. "We wouldn't expect a big fat boom, but a more cautious diversification," says Ergo, Germany's number two primary insurer, and part of the Munich Re group.

Insurers talk of committing the more standard 1 or 2 per cent of assets to hedge fund products.

Funds of hedge funds must sharpen their acts

As pension schemes across Europe look towards hedge funds, funds of hedge funds must look inwards at their structures to ensure they can compete for a slice of this business.

Clearly it is the better integrated businesses that are winning pension fund allocations. By 'better integrated' we mean those businesses that have streamlined their operations from back office to front office, from fund administration and valuations through to marketing presentations combined, above all, with consistent and  positive performance  based on strong and transparent products and smart investment  management.

Those that have failed to invest in building the above factors will have little chance in competing for institutional business and will simply continue to  tread water, raising the possibilities for further consolidation among funds of hedge funds and financial services groups with strong distribution capabilities.

Sunil Gopalan

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