International institutional investors are making long-planned moves into hedge funds, saying the timing is right now that risks have receded and opportunities abound.
“Clients who held off on making allocations are, as they begin to feel more comfortable, going ahead and making allocations to hedge funds,” said Simon Fox, principal and coordinator for European hedge funds-of-funds research at Mercer LLC, London.
Funds taking the plunge include the £23 billion ($37 billion) Universities Superannuation Scheme, or USS, Liverpool, England; the $25 billion Korea Investment Corp., Seoul; and the £6 billion West Midlands Pension Fund, Wolverhampton, England.
Investors and consultants say market dislocations and volatility will make for good investment opportunities. Plus, the economic downturn has given investors more bargaining power on fees and terms, better access to top managers and a clearer picture of what they're investing in.
“There are a lot less assets chasing opportunities. There are fewer funds, too,” said Emily Porter, portfolio manager for absolute-return strategies at the universities plan.
Investment consultants agree that conditions have improved, but warn that investors still need to be cautious. Last fall, Mercer and Watson Wyatt Worldwide Inc. consultants told clients to hold off on making hedge fund investments as liquidity, redemption, counterparty and regulatory risks loomed. But it is a different story today.
“Redemption pressures (that were substantial in the fourth quarter) have dissipated,” said Damien Loveday, senior investment consultant, manager research, at Watson Wyatt in London. “You saw a large number of managers that were susceptible to heavy redemption pressures, and there was great uncertainty on future possible redemption pressures. Those pressures and the liquidity needs and motivations of the underlying investors seem to be clearer now.
“Over the last couple of months we have communicated to clients that those that were ready to pull the trigger (on hedge funds) should start to move back in and undertake that implementation,” he said. New interest is sprouting among clients making their first hedge fund investments, in addition to those moving ahead with plans that had been put on hold, he said.
Mercer outlined seven principles for clients to consider, including assessing liquidity and counterparty risks, demanding greater transparency, and challenging fees and pricing of losses of fund assets.
USS, whose previous hedge fund exposure was limited to £200 million in replication strategies, has begun searching for about 25 managers to run an average of about £50 million each, however the mandate size will vary significantly based on the strategy — larger for core strategies and smaller for tactical and niche strategies.
Ms. Porter defined core strategies as those the fund would hold throughout a cycle, tactical as being marked by temporary pricing disparities and niche as “anything exciting.” Allocation to hedge fund strategies will be dynamic.
“We feel we have sufficient internal resources to manage a diversified program ourselves, but we won't rule out funds of funds,” especially for specialized strategies, said Mike Powell, head of alternative assets at USS. The fund is continuing to add staff to oversee the new portfolio. Managers will be hired over the next two years.
The pension fund began building its alternatives portfolio in September 2006 and increased it opportunistically after the onset of the global financial crisis. Alternatives now constitute about 10% of total assets, with a 20% target.