Australian superannuation funds, which are pension schemes to which employers are required to make compulsory contributions, have about A$1.4 trillion ($1.24 trillion) in assets under management, according to the Australian Prudential Regulatory Authority. An estimated 10% of those assets are invested in alternative investments such as hedge funds, real estate and private equity.
According to those in the industry, a maturing market and disappointment with external manager or fund selection into alternatives is encouraging
the superannuation schemes to turn to in-house expertise. Sunsuper, an independent multi-industry superannuation scheme, and the
largest in Queensland, is one such fund. It has just hired a portfolio manager to refine the fund’s strategy for investing in absolute-return products. CIO David Hartley says: "We do already invest in absolute-return products and have hedge fund investments as part of a global tactical asset allocation strategy. The newly hired portfolio manager will develop a model to include those funds we have, but actually extend that model in respect to the selection of individual funds."
Hartley says that Sunsuper did invest with two funds of hedge funds but now invests with just one. "Funds of hedge funds generally speaking have not been hugely successful for institutional investors here in Australia," he says. "Funds of private equity funds seem to have had more traction. For us it makes sense to build an in-house manager of managers model as it will allow us to get closer to the actual hedge fund managers. There is some scepticism about investing in hedge funds and whether some of the returns are just beta dressed up as alpha. By getting to know the funds, we will be able to make sure what we are paying for is what they are delivering."
As the market matures, the need for funds of hedge funds is waning, say some superannuation funds. "Three to five years ago, it was a real challenge to discover managers. It is still a challenge, but more hedge funds visit Australia now and, in recent times, prime brokers have made inroads here and can introduce hedge funds to institutional investors," says Keith Dickie, investment director at the A$40 billion Victorian Funds Management Corporation in Melbourne. "I think larger investors are becoming more comfortable with choosing funds themselves."
Dickie says that the scheme has always invested directly with managers but will use funds of hedge funds only if the value they add justifies the extra layer of fees. "Funds of hedge funds are suited to high-net-worth clients and smaller institutional funds that want a highly diversified portfolio of managers, and that are looking for high single-digit returns and low single-digit volatility. Our objective is not to have a diversified portfolio of hedge funds. We have a diversified overall portfolio. We want hedge funds because they add alpha, not to save us in the event of a market crisis. Furthermore, we believe the standard measures of risk and volatility to be poor measures. There is a lot more tail risk going on, and funds of hedge funds don’t necessarily advertise that in their quoted risk-adjusted returns – neither do hedge funds themselves for that matter.
"We want to identify managers that add value to a portfolio so we can afford to sit back and build a portfolio slowly. We’re not forced to put cash to work straightaway with hedge funds. That doesn’t require a 15-person team either. And the amount we allocate to them is determined by the damage they can do to the overall portfolio."
More damage
The reputation of outside help to select funds as a means of investing in alternatives was further damaged this summer when Grange Securities, an investment and advisory services company acquired by Lehman Brothers early this year, advised several Australian local councils to invest in CDO funds. Some of the CDO funds were invested with its parent company, and were hit by sub-prime losses. Although Grange Securities ensured that the councils received most of their money back, questions have been raised about entrusting money to an external adviser. "While the firm took the path of least resistance and got out of hot water, there is certainly an element of cautiousness now for Australian superannuation funds. In-house selection probably would have uncovered the fact that these investments were too good to be true," says a portfolio manager at a superannuation scheme.