UK public pension funds most commonly invest in large, well known European and US based fund of hedge funds. Preqin suggests, but there are exceptions to this rule with some pension funds such as the Hampshire County Council Pension Fund choosing to invest all their capital directly.
Preqin believes that 2009 will be another growth year for hedge funds gaining capital from the UK pension fund market. The firm claims that at least 10 public pension plans are intending to make their maiden investment in the next 12 months.
| Key facts - UK Public Pension Funds | |
| Average allocation to hedge funds | 4.18%/£88.1m |
| Average target allocation to hedge funds | 5.06%/£106.7m |
Fg.4 – Top 10 UK Public Pension Funds in HF Allocation to H(£mn)
| Top 10 UK Public Pension Funds in HF | Allocation to HF (£m) |
| Avon Pension Fund | 445 |
| West Yorkshire Pension Fund | 352 |
| Civil Aviation Authority Pension Scheme | 278 |
| South Yorkshire Pensions Authority | 129 |
| Lancashire County Council Pension Fund | 110 |
| Royal County of Berkshire Pension Scheme | 105 |
| Bedfordshire County Council Pension Fund | 96 |
| Sharpshoot County Council Pension Fund | 96 |
| Leicestershire County Council Pension Fund | 90 |
| Hampshire County Council Pension Fund | 88 |
Source: Preqin Hedge Fund Investor Spotlight
West Yorkshire Pension Fund currently allocates £352m to hedge funds. The fund has a preference for fund of hedge fund vehicles and targets returns of around 7.5 per cent.
West Yorkshire made its maiden commitment to hedge funds in 2005 and was amongst the first UK pension funds to invest in the asset class.
Stuart Imesen, West Yorkshire's head of pensions and investments, says: "Four years ago we commenced a strategy of investing up to 5 per cent of the total investment portfolio in fund of hedge funds over a 3 to 4 year period. In view of this incremental strategy, the allocation to fund of hedge funds of 4 per cent now is around 2 per cent more than it was two years ago."
He continues: "Our investment in fund of hedge funds was a means of further diversifying the investment portfolio and reducing risk and volatility, and we take a long-term view. In the last six months whilst hedge funds have produced negative returns, they have performed better than, for example, UK equities over the same period and with less volatility."
Turning to the issue of future allocation to hedge funds, he says:
"We may consider investing more in fund of hedge funds to get to the 5 per cent target originally set, but we have no plans to invest further in fund of hedge funds at the present time until stock markets, and the hedge fund industry, have settled down. It could, therefore, be some time in the future before we feel comfortable in investing further in fund of hedge funds."
West Yorkshire Pension Fund Asset Allocation
| Asset Class | % of Fund |
| UK Equities | 34 |
| Overseas Equities | 28 |
| UK Bonds | 9 |
| UK Index Linked | 5 |
| Global Bonds | 4 |
| Property | 4 |
| Fund of Hedge Funds | 4 |
| Private Equity | 5 |
| Currency Funds | 2 |
| Cash | 5 |
Source: Stuart Imeson, head of pensions and investments, West Yorkshire Pension Fund
The Avon Pension fund has also pledged to maintain its current 10 per cent allocation to hedge funds.
In December 2008 it said: "The inclusion of property and hedge funds should reduce the overall volatility of returns without significantly altering the fund’s expected long term return. The reduction in volatility results from property and hedge funds having a low correlation to both bond and equity returns.
"In the new structure 52 per cent of the fund is invested in passive mandates which rely on market returns to generate the investment return. In contrast 23 per cent is invested in mandates (hedge funds and active equity) where the investment return is primarily derived from manager skill."
Avon Pension Fund asset allocation
| Asset Class | % of Fund | Expected Return (Long term, p,a) |
| UK Equities | 36% | 7.4% |
| Overseas Equities | 24% | 7.4% |
| Indexed-Linked Gilts | 6% | 4.2% |
| Fixed Coupon Gilts | 6% | 4.4% |
| UK Corporate Bonds | 5% | 5.0% |
| Overseas Fixed Interest | 3% | 4.4% |
| Fund of Hedge Funds | 10% | 7.0% |
| Property | 10% | 6.8% |
Avon Pension fund managers
| Manager | Mandate | % of Fund |
| Barclays Global Investors (BGI) | Passive multi-asset | 52% |
| Jupiter Asset Management | UK Equalities(Socially Responsible Investing) | 5% |
| TT International | UK Equities (Unconstrained) | 5% |
| Invesco Perpetual | Global ex-UK Equities (Enhanced Indexation) | 6.5% |
| State Street Global Advisors | Europe ex-UK Equities (Enhanced Indexation) | 3.5% |
| State Street Global Advisors | Pacific inc. Japan Equities (Enhanced Indexation) | 3.5% |
| Genesis Investment Management (Genesis) | Emerging Market Equities | 3% |
| Royal London Asset Management (RLAM) | UK Corporate Bond Fund | 5% |
| Man Investments | Fund of Hedge Funds | 4.5% |
| Gottex Asset Management | Fund of Hedge Funds | 2.5% |
| Signet Capital Management | Fund of Hedge Funds | 2.0% |
| Stenham Asset Management | Fund of Hedge Funds | 0.5% |
| Lyster Watson | Fund of Hedge Funds | 0.5% |
| Schroders Investment Management | UK Property (subject to contract) | 5% |
| Partners | Overseas Property (Subject to Contract) | 5% |
Source: Avon Pension Fund, administered by Bath & North East Somerset Council, figures confirmed to December 2008
Other examples show that although exposure to hedge funds specifically may not be increasing, there is an increase in exposure to alternatives overall.
Lancashire County Council Pension Fund
Original mandate in September 2007
| Asset Class | Allocation (%) |
| UK Equities | 35 |
| Overseas Equities | 28 |
| Bonds | 20 |
| Property | 7 |
| Private Equity | 3 |
| Hedge Funds | 3 |
| Cash | 4 |
Proposals for future asset allocation
| Asset Class | Allocation (%) |
| UK Equities | 30 |
| Overseas Equities | 30 |
| Bonds | 20 |
| Property | 10 |
| Private Equity | 5 |
| Hedge Funds | 3 |
| Other Alternatives | 2 |
Source: Lancashire County Council Pension Fund
By contrast, a survey of institutional investors across the UK, Europe and the US by SEI and Greenwich Associates in November suggested that only 19 per cent of pension funds, endowments and foundations planned to increase their target allocation to hedge funds, down from 44 per cent in a similar survey in August.
The survey also found investors were "significantly tightening their investment criteria. Investors are going to be far more sure footed about who they are going to allocate to and are going to do more due diligence," said John Alshefski, managing director of business development at SEI.
In addition, a pension funds survey in December 2008 by financial services consultants bfinance also indicates a shift in attitudes towards hedge funds.
The survey covered 10 countries and 32 pension schemes, both corporate and sovereign, with an average AUM of €5.4bn. The minimum AUM among the participating schemes was €250m while the maximum was €37bn, and the largest group of respondents were located in the UK (43 per cent).
Investors were asked how recent market events would impact investors’ portfolio structure for each asset class. The responses confirmed that pension funds are likely to increase their allocations to alternatives (GTAA, private equity, infrastructure, FoHFs, hedge funds) and to turn more passive in traditional asset classes such as equities and fixed-income.
However a majority of respondents (60 per cent) said they were disappointed with the fees they pay for actively-managed FoHFs. Not one said they get good value from FoHFs and only 40 per cent say they get fair value.
"In the past, we were in actively-managed FoHFs with a one and two-year lock up," says Richard Grottheim, CIO of Swedish government pension fund AP7.
"Liquidity is one reason why we have been migrating out of FoHFs and into FoHF replicators. I would like to have the possibility of quick withdrawal in times of crisis."
According to bfinance, Grottheim’s exit reflects the break in trust between pension funds and FoHFs which some believe have failed to sufficiently deliver their multiple objectives of de-correlation, diversification, lower volatility and absolute performance. AP7 has increasingly turned to alternative beta strategies such as hedge fund replicators.
"As a rule of thumb, investors paid 2 and 20 for a FoHF. Replication strategies cost less than 75bps. Since last summer, our FoHF replicators have been performing in line or better than FoHFs,"Grottheim says.
UK pension fund LPFA does not invest in hedge funds and has no plans to do so, and investment director Vanessa James believes there is a shift in attitude from pension funds towards hedge funds:
"Hedge funds that are transparent and can explain what they are doing have a chance; those that do not have none whatsoever,” James says.
"The advantage of diversifying your portfolio is that you reduce the volatility that you get from equity markets. However, the theory hasn’t stood up that well because this has been such an unusual unprecedented crisis where basically there is not much that hasn’t gone down apart from cash. Unless you happened to be invested via Iceland."
"Some government bonds have done relatively well but then you have to question that because of the amount of supply that is going to come on so there are not many places for a safe haven."
James continues: “People will be looking in general to where they have go their money and where they expect the long-term returns will be but the fact is most pension schemes have got very long term horizons. As long as you don’t think the end of the world is nigh, which I don’t, then this is a good time to commit funds but you have got to look at the potential returns which are coming from diversified and equities. You have to always be looking at what the potential risk rewards are.”
According to Financial Express Analytics, UK pension funds would appear to be better off investing in traditional assets rather than alternatives.
The best performing UK pension fund predominantly investing in equities over the last twelve months was the Legal & General Neptune Japan Opportunities fund, which generated a 12-month return of 86.26 per cent to 27 January 2009.
By contrast the Zurich Guaranteed fund, which invests in hedge funds, generated returns of -8.48 per cent over the same period , and SLC's Confederation Staffguard fund, which invests in structured products, generated returns of -20.74 per cent.
Performance of funds over the past year
Source: Financial Express Analytics
The most viewed pension fund on Trustnet.com over one year is Stan Life Managed Pn S1.
The most viewed pension fund on Trustnet.com over one month is Nu Balanced Managed Pn.
A breakdown of its asset allocation shows UK equities at 44.4 per cent, fixed interest 18 per cent, European equities 9.3 per cent, North American equities 7.8 per cent, Asia Pac ex-Japan equities 5.2 per cent, property 4.8 per cent, money market 4.4 per cent, Japanese equities 3.3 per cent, global EM equities 2.7 per cent, global convertibles 0.1 per cent, which suggests little exposure to alternatives.
Rob Gleeson, an analyst at Financial Express Research says: "Hedge funds benefited during the boom years from a huge increase in the amount of institutional money invested in the industry. Many of these institutions were probably ill prepared for the combination of high fee, high losses and limited transparency and have since retreated. To woo back these investors, the industry will need to undergo substantial reform."
To conclude, whilst a number of local authority schemes appear to remain committed to the promise of lower correlation, lower volatility preferred by alternatives, the survey responses outlined above suggest that institutional investors as a whole are less sanguine.
The actual performance data suggests those being exposed to alternatives via their own pension funds should keep an eagle eye on the asset allocation as well as returns. In the current environment there is particular concern about yields, especially as a large number of final salary schemes are threatened with closure, and it remains debateable whether exposure to alternatives address the issue.