Does your pension fund use private equity & hedge funds?

cepheus

Here is another comparison, this time with index Linked Gilts.

cepheus

Personally, I would expect an absolute return fund to use options (such as writing long dated covered calls or writing long dated puts with the proceeds placed in gilts to smooth out volatility. I'm not sure what the returns would have been though, but this is purely mechanical and shouldn't require highly paid managers.

These examples are based on the S&P index and are short dated but work on the same principle.

I think guaranteed equity bonds which have been discussed on this board before uses long dated options to guarantee the terms.

bowlhead99

cepheus wrote: »

I think the article was highlighting that the public rarely understand what goes on inside their pension because these decisions are made for them. Perhaps pension providers should have to display the costs of all the investments so they can judge if they are getting value for money. Surely that isn't unreasonable?

Firstly, as others have said, the returns delivered after fees against the perceived risk you took to get the return, is the more useful measure, even though the risk can be pretty hard to quantify.

But sticking with your line of thinking for a moment, a simple list of investments and what they cost to run in a particular year (which can vary) against that particular year's or three year's or five year's performance (which can vary) is not adequate information to evaluate whether the investment should be in a portfolio.

Using private equity as an example, certainly in year one when a chunk of money has been drawn down from the investor to date against its 10-12 year commitment and mostly spent on management fees and establishment costs, and the first underlying private equity deal has yet to close, you could be looking at 95% fees on what you've actually put in. Later you might lose 1% of average assets to fees in a year; and later still you might pay greater than 20% of profits in fees one year as the manager takes his performance incentive fee, having qualified for it by achieving a hurdle rate over the entire life of the investment. Only by assessing well after the fact, and comparing against truly comparable investment opportunities, can you see with hindsight how it worked out and whether the manager did deliver a top quartile return like he projected.

To make any judgement at all, you need to fully understand the nuances of the fee structure and be armed with all the information the pension fund advisory board was armed with when it made its assessment to subscribe to the fund. That will include hundred page legal documents and marketing documents plus term sheets and and individually negotiated side agreements, and a thorough analysis of the opportunity coming out of professional-level due diligence by people who have sat down with the fund manager face to face and fully understood the opportunity, the track record, and the costs.

Such investments, due to their complexity and illiquidity are not available in the mainstream markets to the man on the street. The FCA specifically stops them being marketed to retail investors. Those without all the facts, figures and a number of years professional experience are only really going to be able to say about a high fee: "hmm, that might be very poor value for money if it doesn't work out".

While it might give you some comfort that you are "keeping your pension advisory committee in check" by demanding to see what fees are paid, the value you get from a simple summary is minimal because fees are not everything.

The value you get from a complex summary is also minimal, because it will be very burdensome to review even if the confidentiality agreement between the underlying manager and your pension plan trustee allowed him to reveal the commercially sensitive information about the private fund to you as the man on the street, which it likely won't.

No doubt your pension has investment policies and procedures and guidelines, covering the asset allocation and manager selection/deselection process. As mentioned in my first post, it could be useful or interesting for you to ask pointed questions around those, rather than trying to get bogged down in the minutiae of detail around specific fee levels of individual holdings.

Masomnia

IronWolf wrote: »

That graph looks like the absolute return funds are doing a pretty good job imo

That's what I thought. At the end of the graph ok the AR fund is lower, but during the massive dip in 2008 the AR fund held up very well. Behaved exactly as it is supposed to.

cepheus

bowlhead99 wrote: »

So basically over the 8.5 year period to 30 June, absolute return funds delivered just over 60% while FTSE 100 delivered just over 70% with a massive amount of extra volatility.

The way I always look at an investment is relative to inflation. The real returns were:

FTSE100 44.7%
Index Linked Gilts 36.9%
Absolute Return 26.7%

The other issue is how different assets are correlated. If similar annual returns could be obtained through more or less gearing there is nothing really achieved as Shaxton says.

Ark_Welder

cepheus wrote: »

The way I always look at an investment is relative to inflation. The real returns were:

FTSE100 44.7%
Index Linked Gilts 36.9%
Absolute Return 26.7%

The other issue is how different assets are correlated. If similar annual returns could be obtained through more or less gearing there is nothing really achieved as Shaxton says.

The same exercise done in July 2011 show something different. Do the same exercise in another 12 months and there might also be a totally different result. This is one of the problems with using historic data: it will be possible to show that XYZ Asset is 'better' or 'worse'. But it doesn't guarantee that it will be the best/worse over the next 12/24/60/240 months.

Showing just what the returns have been over a period only tells us the start and end points: it says absolutely (;)) nothing about the journey. And the path taken to the destination can be of more importance than the actual destination, especially when a fixed timescale is involved. What the graphs do show is that Absolute Return has demonstrated a lower level of volatility than both equities and gilts over the period.

cepheus

The drawdowns look quite similar to me, about the same after adjusting for the higher return of linkers, but we are dealing with 10 v 15% anyway so not much on the timescale of a pension. Yes we could use 2011, or indeed cut out just one year 2005! The absolute return index doesn't return hardly anything in real terms after that date.

Normally the risk premium of a product is assessed relative to something like Index Linked Gilts, because these are underwritten by a major sovereign government and are therefore, not dependent upon the liquidity of companies to honour contracts. Perhaps these absolute return funds would be worthless in a really serious crash. I know the GEB I had, which isn't that different to an absolute return, was dependent upon the liquidity of the underlying counterparties.

Hence we return to the same question, what are the absolute return funds providing what we can't get elsewhere?

I'm not saying they are definitely useless but it seems reasonable to me that if the fund manager is taking a significant cut out of our money they should have to justify their fee by demonstrating skill, in this case by beating a basic mechanical option strategy. Of course that applies to all active management.

grey_gym_sock

cepheus wrote: »

Hence we return to the same question, what are the absolute return funds providing what we can't get elsewhere?

i don't think there's anything special about them as a class. as i said, they may be similar to a "balanced" fund, holding a mixture of equities, bonds, etc.

that's not necessarily bad at all.

it is bad if they're over-charging.

it is bad if they're taking excessive risks - trying to be too clever.

personally, i don't like funds where the manager is free to go short as well as long. to my mind, it's not a sensible risk to take - i invest because i expect other assets classes to beat cash, not because i think the manager is clever (a clever manager should at most be the icing on the cake). that would rule out many "absolute return" funds.

the whole marketing of "absolute return" funds seems rather misleading to me, because they can't really achieve a target return consistently year by year. they can achieve smoother returns than 100% equities.

Ark_Welder

cepheus wrote: »

The drawdowns look quite similar to me, about the same after adjusting for the higher return of linkers,

Drawdown is not the same as volatility. And the higher return from the linkers in this timeframe has occurred only in the last few years. Contrast their fall in the last three months or so with the slight positive return from AR. Does linkers' 18-month performance look like the start of a head and shoulders pattern? Or is it too early to tell? Not my area, just an observation, and one made on the basis of the 30-year downward trend in bond coupons (known in some circles as bubble).

cepheus wrote: »

Perhaps these absolute return funds would be worthless in a really serious crash.

They might. Probably depends upon what crashes and how a particular fund makes its return. A fall just in bonds would likely affect a fund holding equities and cash less that a pure bond fund, even.

No reason to believe that a mechanical strategy would do any better, especially when directional changes are rapid. The performance of AHL from Man Group in the last few months, and since 2009, being an example of relying on a computer-driven strategy.

cepheus wrote: »

I know the GEB I had, which isn't that different to an absolute return, was dependent upon the liquidity of the underlying counterparties.

This section might be of interest, re. charges: Comparison of the costs of investing in [Guaranteed Equity] bonds and trackers starting on page 6: http://www.investmentfunds.org.uk/assets/files/research/20110411-GEBSresearch.pdf

cepheus wrote: »

Hence we return to the same question, what are the absolute return funds providing what we can't get elsewhere?

Lower charges than on GEBs, perhaps?

cepheus wrote: »

...in this case by beating a basic mechanical option strategy.

From the small print of the document previously referenced by you (being: These examples are based on the S&P index and are short dated )

Like many passive indices, the indices do not take into account significant factors such as transaction costs and taxes. This paper contains index performance data based on back-testing. Investors attempting to replicate the indices should discuss with their advisors possible timing and liquidity issues.

Back-testing can prove anything, especially a desired outcome. No guarantee at all of future returns, though.

Ark_Welder

Just read this article from the FT. It does contain something for everyone, in some respects. And it does offer up a reason why pension funds have been looking more at alternative strategies.

Google FT headline: Markets: The investor’s dilemma