Tuesday, December 8, 2009

Seeking Alternatives in Hunt for Yield?

Walden Siew of Reuters reports that pension funds seek alternatives in hunt for yield (hat tip Mike):

Large public pension funds in New York, California and Ohio are looking increasingly to alternative investments in hedge funds, private equity and emerging markets in a global hunt for yield, senior managers and trustees said.

The global credit crisis has put a squeeze on money managers who must try to boost returns by looking at nontraditional investments that are a growing allocation in some portfolios, in some cases making up more than a quarter or more of fund holdings.

"We're going to act prudently and be hesitant to rapidly increase our assets to alternatives, but we're pretty much of the opinion that that's where you have to be," said Joe Alejandro, treasurer of the New York City Patrolmen Benevolent Association, during an Alternative Investment conference on Sunday.

Recession has hit states including Ohio hard but alternative investments in areas such as real estate and casinos may present opportunities, added J.P. Allen, investment committee chairman of the Ohio State Highway Patrol retirement system.

"When things are bleak, now is the time to buy, when there's blood on the street," said Allen, who said its fund benefited from real estate and timber investments in 2008. It has since pared back on some of those investments, he said.

The California Public Employees' Retirement System, or Calpers, the world's biggest public pension fund with over $200 billion in assets, spearheaded the move by public pensions into alternative investments.

Calpers invested in private equity, high-end vineyards and hedge funds in the late 1990s and early 2000s. But not all of those investments fared well. A $500 million equity investment in Manhattan's Peter Cooper Village and Stuyvesant Town, a sprawling apartment complex, has drawn criticism.

The venture's partners are now close to defaulting on $3 billion of debt and the equity has been wiped out.

New York's Alejandro said his current allocation is about 70 percent equity and about 25 percent in alternative investments, which he would like to increase to between 30 and 35 percent. He said he has made a push for greater investments in hedge funds of funds, private equity and real estate to the new comptroller, who starts in January.

About 350 hedge fund managers, trustees and treasurers attended an Alternative Investment conference that began on Sunday held at the Ritz-Carlton in Dana Point, California, sponsored by the Opal Financial Group.

That's down from about 400 participants last year, organizers said, and a sign of how the market for complex investments has shrunk.

More than 1,000 participants attended the group's annual Collateralized Debt Obligation conference before the credit crisis hit two years ago. The group has since canceled its annual CDO and CLO conference and focused on alternative investments.

Keith Rodenhuis, trustee of the $7 billion Orange County Retirement System, said he holds about a 10 percent allocation in real estate, 7 percent in "absolute return," which includes hedge fund positions, and 5 percent in private equity.

Rodenhuis said his fund boosted "real return assets" to 13 percent from 10 percent, involving investments in commodities and timber. The fund cut back investments in international fixed income to boost those real return assets, he said.

The fund is looking to allocate from zero to 5 percent in opportunistic investments such as distressed mortgage funds.

"We're hoping that slowly climbs back," said Rodenhuis, who also sees opportunities in energy, green technology and local medical technology, as "Orange County is a hotbed for medical technology," he said.

Ohio's Allen said many retirees took hits in the wake of the global credit crisis, but alternative investments in timber and real estate in 2008 helped offset losses, although he has since sold some of those assets to book profits.

So some pension funds are preparing for a down market by investing more into alternatives. I hope they know what they're doing because it could backfire on them. Another reason why pension funds invest so much into alternatives? Leverage. They can allocate to outside funds and use the power of leverage to juice their returns. Again, this could backfire on them.

Finally, not all pension funds are so bent on alternative investments. Last week, the WSJ reported that UK pensions funds pull out of private equity:

The UK's pension schemes halved their allocations to private equity and real estate, according to the most comprehensive annual survey of the sector, pulling out some of their capital in the wake of falls in value.

A survey of 300 schemes with a total of GBP410 billion (EUR450 billion) of assets, just published by the National Association of Pension Funds, showed the average allocation to private equity fell from 2.5% to 1%, as at the end of June each year.

The decrease was due to pension schemes reducing their exposure to the asset class. Some schemes pulled out altogether, with the proportion of schemes with some exposure to private equity falling from 24% last year to 21%.

Only 3.9% of UK pension schemes' assets are allocated to property this year, compared with 7% last year and 7.5% in 2007. The proportion of schemes invested in property fell from 64% last year to 61%.

Schemes had been unpleasantly surprised by the severe falls in the property market, according to the authors of the NAPF survey, who said: "Previously low-risk investment options such as property have seen large fluctuations in value over the past two years."

Pension schemes have continued to increase their allocation to hedge funds, however. The proportion of schemes invested in hedge funds have risen from 17% in 2007 to 24% last year and 26% this year. The average allocation of those that have invested in hedge funds rose from 6.7% in 2007 to 7.8% last year, and was maintained at 7.8% this year.

The overall allocation across all pension schemes, a function of more schemes investing and steady rates of exposure, has gone up from 1.2% in 2007 to 1.9% last year and 2% this year.

Pension schemes moved the capital they took out of private equity and property into global equities. The overall allocation to this asset class went up from 6.6% last year to 12.8% this year. This confirms the reports of investment consultants including Watson Wyatt, which have performed more searches for global equities managers than any other, on behalf of their clients.

The allocation to UK equities fell from 21.1% last year to 19.5%. This confirms a long-term trend of UK pension schemes diversifying away from exposure to UK financial markets.

Publication of the reductions in property and private equity has come just as a trio of Dutch academics publish a report that concludes investors are wasting their capital if they invest in private equity and hedge funds.

It looks like the lustre of private asset classes isn't as strong over in the UK. I don't blame them. It could be years before we see another sustained uptrend in private markets, but don't tell this to North American pension funds. They're busy investing in the next big buyout fund hoping that the golden age of private markets will come roaring back again. They will be sorely disappointed.


Tom Croft, author of Up From Wall Street: The Responsible Investment Alternative, was kind enough to send me his comments on dark pools:

Back into the Dark Pools

By Tom Croft

Public pension funds may be doubling down, to head right back into mega-private equity and hedge funds. Pension fund managers from CalPERS to Orange County to the New York City Police Benevolent Association say that, despite the massive fall-out from the market crash due to excessive risk-taking, they are now getting back in the dark pools.

Hedge funds were originally designed as an investment program for wealthy investors. Then hedge assets boomed over the last decade, growing ten-fold from 1998 to 2008 (to over $2 trillion). From 2002 to 2007, the share of dollars in hedge assets coughed up by institutional investors—including university endowments, foundations, retirement trusts and insurance funds, etc.--jumped from 2% to 50%. That’s a lot of money for what became, in essence, a Wall Street game to short markets and firms.

And the money pouring into private equity, climbing by 2006-2007 to $301 billion, came disproportionately from institutional investors. In the case of the mega-private equity funds, there’s ample evidence that many of the funds over-leveraged their portfolio firms, leading to firm failures and bankruptcies. Or worse, they stripped and flipped their acquisitions (i.e. Simmons, Mervyn’s, Linens ‘n Things). They became, in many cases, the new “Barbarians at the Gate.”

I don’t have to look far to see the damage. Here in Pittsburgh, CMU and the University of Pittsburgh filed fraud lawsuits against Westwood Capital —ostensibly a hedge fund-- this past Spring after their $114 million investment cratered. And the Pennsylvania public pension fund lost an additional $2.5 billion (than they would have otherwise, according to some estimates) by betting on an extremely large hedge fund gamble (almost 1/3 of total portfolio). And, it’s been just under two decades that Orange County declared bankruptcy after a $1.5 billion loss in derivative and other exotic alternative investments.

States and municipal pension funds are cash-strapped. That’s no reason to bet the farm. There’s plenty of responsible alternative pension investors who build up firms, build real affordable housing, and help grow the economy. We need to turn off the spigot to speculators, who tapped both cheap money and our priceless retirement trusts over the past five years. Stay in the shallow end.


Tom Croft, an international expert on innovative capital strategies and Director of Pennsylvania’s Steel Valley Authority, is the author of Up From Wall Street: The Responsible Pension Alternative (Cosimo Books, 2009).

No comments:

Post a Comment