By Joel Kranc
In recent years, pension funds have increasingly turned to hedge funds as a way to enhance returns and manage risk. Hedge funds, traditionally seen as a high-risk, high-reward investment class, have become a more prominent part of the investment portfolios of pension funds globally. This shift reflects broader changes in pension fund strategies, as they seek to address challenges like interest rates, market volatility, and growing liabilities.
To that point, according to a Funds Europe report, which cites Beacon Platform, a 33-pension fund survey showed that 33% of pension funds in the US, UK, Germany, Switzerland, France, Italy, Hong Kong and Singapore expect the hedge funds industry to add more than $190 billion in assets this year. Twenty-seven percent think that increase will be in the $250 billion to $500 billion range.
The study highlights that all the pension funds surveyed view hedge fund investments as appealing in terms of risk-adjusted returns over the next five years, with 15% describing these investments as “very attractive.” This optimism is fuelling expectations for a substantial allocation increase, despite current market volatility.
Also, 88% believe that the quality of information and transparency within the hedge fund industry needs to improve, with 27% saying the improvement needs to be dramatic. In Canada, some of the larger funds hold hedge funds but in relatively small amounts to their overall asset allocations.
For example, according to a report from PWL Capital, Twelve Observations about the Big Canadian Pension Managers, AIMCO holds 4% in hedge funds; HOOPP has 5%, IMCO 7%, Ontario Teachers’ Pension Plan 8%, for a total average of 3% (as of Dec. 31, 2023).
But what of its value and performance to the funds?
Richard M. Ennis, in a piece for the CFA, writes, “…Diversified hedge fund investing appears to have underperformed in modern (post-Global Financial Crisis) times. For the 15 years ending June 30, 2023, the HFR Fund-Weighted Composite Index had an annualized return of 4.0%. This compares to a 4.5% return for a blend of public market indexes with matching market exposures and similar risk, namely, 52% stocks and 48% Treasury bills. By this measure, the hedge fund composite underperformed by 0.5% per year.”
However, this year is slightly different from last, perhaps due to a decrease in interest rates and inflationary pressures. “Hedge fund confidence rose in the third quarter supported by stronger performance outlook and better capital raising prospects,” notes Tom Kehoe, Global Head of Research and Communications at AIMA. “Both large and smaller funds cited higher sentiment with the latter seeing a notable improvement resulting in the overall confidence score being at the highest level in a year.”
Similarly, Steve Nadel, Partner with Seward & Kissel, explains: “Q3 2024 continued the see-sawing confidence trend we first detected back in 2022 where confidence goes up one quarter and down the next. However, given the extremely strong confidence demonstrated in Q3, especially in North America, UK and long-short equity categories, we may be witnessing a breakout from previous trend lines. This may be attributable to, among other things, increased clarity in the various positions of the two US Presidential candidates and the recent decrease in interest rates.”
But the seesaw effect of hedge fund volatility may be too much for large-scale investors to stomach. A Prequin investor outlook report said that only seven percent (of 185 institutions) considered hedge funds as an inflation hedge. Also, 18% said they plan to keep their hedge fund positions and 47% planned to keep their allocations. Interestingly, 35% plan to decrease their allocations, which are up from 25% last year. Many — 68% — are deferring decisions until 2025. Sometimes the journalist cliché is true: time will tell.
