With volatility and uncertainty weighing on the current financial climate, consultants tend to prefer strategies that can potentially protect investors in volatile periods.
Roger Fenningdorf, head of manager research, founder and partner at Rocaton Investment Advisors points to defensive or diversification strategies such as being long Treasuries, tail risk hedging, commodities, hedge funds or bank loans.
He expects that modest investor frustration with long-only equities and expectations for low fixed income yields should continue to encourage pension interest in hedge funds. With historically low interest rates, he expects the global push into higher risk products to grow.
Fenningdorf also likes strategies in the illiquid space that can take advantage of the aftermath of the credit crisis such as distressed and opportunistic real estate, and distressed strategies in residential mortgages.
In an environment with zero interest rates, pension consultants say their clients have become more globally oriented than before. Chris Abbruzzese, director of research and analytics at Americh Massena says, in the short term, they are interested in distressed opportunities in Europe as macroeconomic turbulence and regulatory changes create mispricings in the corporate debt market. A relative scarcity of capital may make it more difficult for highly leveraged European companies to refinance their debt.
He expects this opportunity to play out over the next four or five years.
Fenningdorf also sees opportunities in Europe. He says Europe will have challenges over the next few years that are likely to provide many profitable opportunities i.e. consumer receivables, corporate credit and real estate – most of it distressed.
Craig Adkins, senior alternative investment research analyst at DiMeo Schneider & Associates, also highlights distressed opportunities in Europe as well as those managers who can take advantage of volatility in emerging markets. He also likes event driven strategies as corporations have a lot of cash on their balance sheets that eventually has to find a home. He also likes long/short equity because it can benefit from volatility in the market.
Abbruzzese also points to material economic dislocations in agriculture, water and energy markets due to long term demographic trends and short term resource scarcity issues.
Funds of funds versus direct investing versus multi-strategy
Adkins points to pensions investing more directly with hedge funds as it will remove a layer of fees and allow the pensions to control who their managers are and the degree of liquidity. Adkins also likes multi-strategy funds because they can be opportunistic and allocate quickly according to their best ideas.
Darren Spencer of Russell Investments says the choice of funds of funds or investing directly with a hedge fund depends on the individual pension’s circumstances. “Funds of funds can be an efficient way to implement the portfolio. For example, some large corporate pensions may have only two to three people responsible for managing the pension and may not have sufficient internal investment resources to build direct investment programs themselves,” he points out.
Emerging managers
Pensions are also becoming more comfortable with emerging managers. Adkins says he may start to bring smaller managers to pension clients if the key business risks are low.
And on September 22, California Public Employees’ Retirement System said it was investing $100 million in seed money with Toronto-based Breton Hill Capital, a global macro hedge fund. This marked CalPERS’ first seed investment with a hedge fund manager. The investment is part of CalPERS absolute return strategies program which was started in April 2002 and has $5.3 billion invested in it as of mid-year 2011. CalPERS also has about $500 million invested with customized funds of funds that focus on emerging managers.
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