Some of Europe's largest pension funds are creating synthetic or passive exposures to alternative strategies as a way to improve risk-adjusted returns.
These “alternative beta” strategies include emerging market equity, high-yield debt, public real estate securities and hedge funds, according to interviews with pension fund executives, consultants and money managers.
“We're only in the early stages, but (alternative beta) is attracting a lot of interest at the moment,” said Paul Trickett, European head of investment consulting at Watson Wyatt Worldwide, Reigate, England. “Right now, those who are looking at this are the very big clients with a lot of resources. But in time, (alternative beta) should attract the smaller to medium-size funds interested in diversifying away from the equity risk premium.”
Among those adding alternative beta exposures include PGGM Advies BV, which manages €88 billion ($133 billion) in pension assets for the Pensioenfonds Zorg en Welzijn, Zeist, Netherlands, and the 445 billion Danish kroner ($95 billion) ATP scheme, Hilleroed, Denmark.
Traditionally, pension officials have indexed widely used capitalization-weighted benchmarks — such as the Standard & Poor's 500 or the Morgan Stanley Capital International World Index — of publicly held stocks and bonds. Alternative beta is defined differently among sources, but in general, it involves using derivatives, non-traditional benchmarks such as fundamental or risk-weighted indexes, and exchange-traded funds to capture market returns from alternative strategies. These new approaches can also be applied to factor exposures, such as those used in hedge fund replication strategies. The potential advantages include diversification of beta sources, reduced costs and additional transparency, consultants said.
“It is quite difficult over the long-term — particularly if you're a large pension fund with lots of active managers — to outperform your benchmarks,” said Paul Boerboom, managing director of independent consulting firm Avida International BV, Amsterdam.
“What we're also witnessing over the past few years is that the dispersion among (active) managers in terms of returns has been very high, so that there's more of a need to actively manage your managers,” added Mr. Boerboom. “Given those factors (among others), some pension funds have decided that they might as well go passive.”