EUROPE - A growing move by pension funds towards hedge fund replication has prompted a warning they could be missing out on the returns offered by funds of hedge funds.
Peter Norman, AP7's executive vice president, told Global Pensions: "We think we can achieve the same risk and return characteristics with this technique compared to FOHF solutions. We plan to replace completely the FOHFs with a hedge fund replication by mid-next year."
Earlier this year, the Universities Superannuation Scheme (USS) appointed State Street Global Advisors (SSgA) to manage a US$200m hedge fund replication mandate, alongside its single manager hedge fund programme.
At the time, Michael Powell, head of alternatives at USS, said: "We are convinced of the merits of hedge fund replication as a way of gaining transparent, liquid and low-cost exposure to the risk premia that drive the majority of hedge fund returns."
However, Phil Irvine, director of advisory services at investment consultancy Liability Solutions, warned the possibility of hedge fund replicators achieving the same level of returns, considering their lack of
track record, was very limited.
He said: "The idea of replication is that these products should be mirroring the industry pretty closely, but with that range of returns there is a lot of risk in the product selection which isn't implied by the term
While performance of hedge fund replication continues to be questioned, pension funds are attracted to the lower fees and liquidity on offer.
Robert Howie, principal at Mercer, said fees for hedge fund replicators would go down even further in the future, once more experienced was gained.
But, he added, while the liquidity aspect could represent an attractive factor for pension funds, replicators would not be able to capture the returns FOHFs generate by investing in more illiquid assets.
Asset managers also pointed out the benefits of FOFHs over hedge fund replication. Chris Trower, director of sales and marketing, Corazon Capital, said: "Skill based investing at FOHF level, where you are using your knowledge to find the best managers and to blend those into a meaningful portfolio that can give you genuinely uncorrelated returns cannot be done by replicators."
And Laurent Seyer, CEO, Lyxor Asset Management, added the ability of these products to replicate was only partial and, according to his company's analysis, they replicated well in bullish market conditions.
He explained: "The returns of FOHFs are made of three elements. One is the traditional beta [coming generally from exposure to fixed income and equities], which you can replicate. But you can't replicate the alpha of the manager and the alternative beta that comes from hidden assets like productivity."
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