Does your pension fund use private equity & hedge funds?

cepheus

I've just discovered that my (deferred) occupational pension fund is 50% invested in 'absolute return funds' Is this the same as a hedge fund?

According to this article

Private equity firms and hedge funds with their hidden fees don't just skew markets, they often aren't even very good. So why is your pension probably invested with one?

The key thing to understand here is that the managers aren’t the same as the poor, gullible outside investors (your pension fund). The former extract gargantuan annual fees from the latter........

Lack looked at returns for hundreds of funds and concluded that if all the money that has ever been invested in hedge funds had been put into low-yielding, plain-vanilla treasury bills (short-term, government-backed securities), “the results would have been twice as good”, he wrote. The $450bn of investors’ money vaporised by hedge funds in 2008 probably destroyed “all the value that hedge funds ever created”, he wrote. Not only that, but from 1998-2010, judging by one way of calculating it, investors received just $9bn, all things considered, while the hedgies took $440bn. So the hedgies took 98 per cent of the winnings, leaving investors with 2 per cent. That is monstrous.

so in view of the dubious returns should I be asking the trustees some difficult questions?

redbuzzard

There are hedge funds, and hedge funds. I would like to think that the more adventurous, higher risk hedge funds directed at making super returns are not generally run in the same way as say SLI Global Absolute Return Strategies, much beloved of pension funds and in fact designed as the core of Standard Life's own pension funds. But I'm no expert in them.

I assume it is a final salary/defined benefit scheme? How well funded is it?

No reason why, as a member, you can't speak to the trustee - try your member nominated director/trustee who might be happy to share some background, or at least some relevant considerations, with you.

But it shouldn't matter to you if it's DB. Providing there isn't a deficit and a default, your benefits will be unaffected.

The trustee has an interesting job. If the covenant (the financial strength of the employer/sponsor) is strong, the trustee (and the employer) may be happy to take more risk - the employer is on the hook to underwrite the funding requirement regardless.

If the covenant is less strong (remembering that the trustee usually has to look decades into the future) then the trustee will be cautious about any strategy that has a high risk of making the funding position worse, as that would put even more reliance on a shaky sponsor. They may sacrifice growth potential to keep what they have more secure. They have certainly looked to funds like GARs, and managers like Ruffer, to do some of that in recent years.

The conundrum for the trustee is that if there is a struggling employer, a deficit and a big hole to fill, the trustee desperately wants higher returns, but also wants to keep the risk down so as not to make the situation worse.

They will also have regard to liabilities and the timing of those - expected pension liabilities have a duration, just like bonds, and in some circumstances the two will be matched to a greater or lesser degree.

The trustee will also be taking professional advice - e.g. from the actuary, the investment consultants, and they may also have an independent report on strength of the covenant if they have reason to be concerned on that score.

Among other strategies, they may also have self-imposed 'rules' in place to 'bank' any above plan performance in the core risk investments into liability driven bond purchases (the matching above) or AR funds.

EDIT - just found a couple of links that might reassure us slightly -

Types of Hedge Fund

Hedge vs Absolute Return funds

cepheus

No in theory it shouldn't matter as you say, however the pension is draining the employer who is having to put more in. I'm not completely confident they will remain solvent. Perhaps I want to keep them on their toes as well, rather than rubber stamping everything.

redbuzzard

If this is a sizeable fund, the trustees are unlikely to be flying by the seats of their pants. If they have any sense, the seat area will be well covered by professional advice.

The fact that they are using AR suggests that they are at least trying to act prudently. The employer may want them to take more risk to improve returns and keep the contributions down.

If there is a deficit, the trustee will also be trying to negotiate a recovery plan following each full valuation that balances income to the fund with the stress on the employer's finances - that plan has to be signed off by the regulator.

lvader

Some of the hedge funds use sophisticated computer systems to work out the best investments, but government manipulation tends to screw up the formulas.

cepheus

Well the link suggests these may not be as prudent as their name suggests and the only thing which is guaranteed are high fees.

redbuzzard

Yes, tricky isn't it?!

Cash is a guaranteed loser. Bonds are expensive as matched investments and unmatched, risk capital loss. Equities are volatile. Property ditto, plus high cost and illiquid. Some have flirted with private equity investments.

I think a lot of the reason for the popularity of AR with pension funds is the historic performance (GARS in particular). Who wouldn't buy into an annualised 7%-8% return and about a third of the volatility of equities after costs? Everybody has been telling themselves that the total return might well be lower, but that the capital protection is reasonably secure.

For a fund with a stubborn deficit (which has increased every time bond yields have dropped) that seems a panacea.

EDIT - what, if anything, would you want to consider if you were on the trustee board? I imagine they already have a chunk of equity index funds as well as some specialist/EM managed funds?

Thrugelmir

I've held Graphite shares (private equity) since its public floatation.

Unsure why private equity is considered a worse investment than ordinary equity holdings. As some of the Companies invested in, have a higher market capitalisation than those on AIM or the bottom end of the LSE.

cepheus

Unsure why private equity is considered a worse investment than ordinary equity holdings

as explained in the link, it is mainly because of the higher fees they pass onto managers,

Private equity firms and hedge funds with their hidden fees don’t just skew markets – they often aren’t even very good. So why is your pension probably invested with one?.....The sheer uselessness of private equity and hedge funds in delivering returns for investors is an open secret in the City. This raises the trillion-dollar question: why are investors – who probably include your pension- fund manager – still pouring cash into the Mayfair money machine?

however, if those fees are not applicable for whatever reason (as implied in redbuzzards link) perhaps they are reasonable investments.

bowlhead99

cepheus wrote: »

Well the link suggests these may not be as prudent as their name suggests and the only thing which is guaranteed are high fees.

Well, the link is completely anti- hedge funds and private equity funds and "you can read about it in the short e-book I've just published". No thanks, if it's just going to be more one-sided ranting with such a polarized view of the world.

He lumps PE and hedge together when the only thing they have in common is performance fees, and then takes as many out of context anecdotes as possible and crams them together in a scaremongering article which paints the whole industry(ies) as villains that have raped their investors of cash.

He flips between criticising their alignment of interests with investors (how terrible! they charge performance fees and steal your profit) and then moaning that just like a traditional manager getting paid to manage, "two thirds of their earnings come from fixed fees" (oh no! they make money even if they do the work and don't deliver) depending what can be dressed up as most sensationalist for that particular paragraph.

I like the story that "from 1998-2010" (hmm, way to impartially select a period, starting right before the biggest crash in history and then finishing only a year after the market bottom of the credit crunch),"judging by one way of calculating it" (I'm sure a really legitimate and impartial way, right?), "investors received just $9bn, while the hedgies took $440bn. So the hedgies took 98 per cent of the winnings, leaving investors with 2 per cent.".

I'm sure that if that were legitimately true and a valid expectation for someone about to invest in a hedge fund, they would not have investors. Whereas as a general rule, competent and credible institutional investors from government pension funds, corporate pension funds, insurance companies, family offices and corporates with 5-15%+ of their portfolios in alternative assets are not doing all their due diligence and then just "accidentally" investing with these managers because they're idiots or because they forgot to read Mr Shaxson's insightful article screaming at them to "wake up and smell the coffee, sheeple!"

I would not be concerned having a portion of assets in a hedge fund nor a private equity fund. There was a part of the article that suggested that the average (sensationally good compared to pension fund average) net PE return could have been equalled by simply gearing the public market FTSE returns. If that is the case (and top managers would deny it and say you are cherrypicking data) then at least it is not delivering any worse than the FTSE - remembering that the PE returns being achieved are net of all the management and performance fees being moaned about. And given half the businesses on the planet - from your corner shop or taxi firm to PE-owned Alliance Boots- are not in public ownership, the diversification could be useful.

Private ownership to provide capital and strategy to build /improve a business over a four to seven year period rather than being judged by 'the markets' every quarterly RNS, is not a bad idea and many sophisticated investors buy into the PE model. Industry returns since inception are higher than public markets. The only part of private equity that has let the side down in the last couple of decades, as mentioned in the article, has been venture capital, with the hit-rate of VC-backers lagging somewhat behind the buyout and generalist funds.

As others mention there can be quite a difference between the type of 'hedge funds' that get much of the bad press within the incredibly wide range of alternative funds out there, and 'absolute return funds' which are effectively adopting strategies and hedging techniques in an attempt to try to deliver an absolute return through up and down markets rather than being forced to make profits in bull markets and losses in bear markets. Arguably a portfolio construction and strategy designed to make an absolute return year in year out through a multi-asset class fund is more reliable, dependable, less volatile than just being long-only equities or bonds or a bit of both.

Sure, overly-geared investments can be risky, and with some of the larger hedge funds also using a lot of derivatives, and investing in other hedge funds, and using computer modelling to trade on a 'me too' moving average basis following the momentum of the market, there can be contagion and systemic issues arising from the bets being too big and going bad. Some of the issues about reporting transparency, accountability, gearing levels, remuneration, capital adequacy, common standards, existence of assets etc has been addressed by the Alternative Investment Fund Managers Directive (AIFMD if you're interested in googling), developed across Europe in the last few years, handed down by the EU and going live in the UK in a fortnight. This is not equally relevant to all alternative funds (as PE funds for example do not IMHO pose the same systemic risks) but is at least a start by the regulators of trying to exert some control and build up more of a picture of what the 'hedgies' are doing.

Bottom line, just because you read a sensationalist article that said some of the returns could be 'dubious', does not really give you a question for your trustee - other than the ones you would be asking anyway: how do they select their strategy and choose to engage with particular underlying funds/managers as part of the investment plan over a given timescale ; how do they monitor and validate reported performance; what would it take for them to drop a fund or a manager; what kind of track record do they demand before taking on a new manager and what due diligence do they do to investigate it; given the limited capacity of hedge of PE managers to accept new investors into their funds, how do they get access to the desirable ones rather than getting stuck with the dross?

And so on. I could spend quite a bit of time criticising this article and finding counterpoints, but as the guy isn't listening to what I say, I am probably wasting my breath. He gets paid to pump out articles which seem interesting to read. He does not claim to have a balanced view and has written a book called Treasure Islands: Tax Havens and the Men Who Stole the World which I haven't and won't spend a tenner on to see if his novels are better than his web articles. To borrow the last line of his article: the author exists, purely, to serve himself.

bowlhead99

cepheus wrote: »

Thrugelmir wrote: »

Unsure why private equity is considered a worse investment than ordinary equity holdings. .

as explained in the link, it is mainly because of the higher fees they pass onto managers

It is inherently more difficult to negotiate a deal to buy 90%+ of the ownership of a private company alongside its management (or perhaps installing your own management) and guide it over the course of several years before negotiating an exit to another PE group, a trade buyer, or an IPO.... than it is to identify that Tesco is looking a bit cheaper than Sainsbury with results due out at the end of the month, so you'll put a few million in that, and if it looks like it's going wrong (or UK retail is the wrong sector) next week, you can get out without too much harm done.

Complex products offering something unique, can often be expensive, but this does not mean they are not worth the money. Private equity managers typically invest a significant portion of their wealth or income into the fund alongside the external investors, aligning their interests, which together with performance fees gives them a real incentive to do well, and the performance fees can only be taken if a target rate of return is reached. A great many investors look at their returns net of fees and are very satisfied. Some performance statistics here.

Of course for a retail investor's investment in private equity it is typically going to be even more expensive than for an institutional investor, as PE vehicles are only marketed to sophisticated big ticket investors who can understand and afford the product. Therefore you or Thrugelmir investing as the man on the street would normally access the sector through a fund of funds (some would say fund of fees) with the FOF manager taking a fee for constructing and operating the overall portfolio which involves investing into underlying managers' funds each of whom have their own fees. So, more expensive, but quite well diversified.

Also, investing through a listed vehicle typically gives a lower return, at least in terms of IRR, as there is a drag on performance from uninvested cash ; if you were an institutional investor in a private equity partnership, the money would be drawn down by the manager against your overall commitment with ten day's notice as and when the individual investment opportunities arise, rather than having all the cash sitting in a bank doing nothing while waiting to be deployed into deals over a five year period.

I see in the linked "eye-opening" article, which I take with a pinch of salt, refers many time to hidden fees:

Headline: Private equity firms and hedge funds with their hidden fees don’t just skew markets...

"...among other things, private equity firms in particular extract various other, hidden fees."

"Layers of devious, hidden fees in private equity deals, for instance, can be even greater than the brazen shakedown of the advertised 2-and- 20 fee structure"

At no point does he tell us what these layers of hidden fees actually are. It is just shouting loudly and often enough that some people will blindly accept it as truth because they read it in an article which dropped some names of disillusioned investors.

Well, I've read the private placement memoranda and detailed investment partnership agreements for 50+funds over the last few years and know what the model says on the tin and how it works at a detailed operational level, in practice. There are a variety of fees charged to and through different entities. But the investors know what they are and what they will accept and they put together side-letters and carve-outs for whatever terms they need before they invest.

These are typically closed-ended funds (the opposite of a unit trust or OEIC with transient investors) and a fund can take a year to reach its final close getting sufficient investors happy to be on board to be able to execute its investment strategy. There is no way you are telling me there are a significant number of institutional investors writing subscription agreements for $1m to $200m commitment to a fund relationship, without knowing exactly what the fee structure means and how costs and incomes (inside or outside the fund) are shared between investors, the manager and the portfolio companies they acquire.