Long-term returns are compelling over various market cycles, and manager selection remains critical during these uncertain times
The global investment firm suggests only about 250 of the world’s nearly 11,000 hedge funds merit institutional capital
LONDON (January 11, 2017) – Pension fund trustees should keep in mind the real value of hedge funds as a “hedge” against market fluctuations if the global economy continues to suffer turbulence caused by political events and other shocks to the system, according to Cambridge Associates, the global investment firm.
Investors may have lost sight of the role that hedge funds are meant to play in an investment portfolio—as a protector against downside risk. Outflows have become an increasingly common trend due to the recent period of underperformance. Yet hedge funds’ “forgotten benefit” as capital protectors should now be re-evaluated and reconsidered. Political and other shocks may exacerbate an already challenging situation for many pension schemes, which are facing a widening funding gap as a result of persistently low interest rates.
“There is no doubt that hedge funds have provided a counterweight to equity and bond investments in a portfolio,” says Trudi Boardman, senior investment director at Cambridge Associates in London. “We’ve been executing alternative investment programs within institutional portfolios for more than 30 years and have witnessed the value that hedge funds have brought to investors who have maintained a long-term mindset and an ability to weather various market cycles, including periods of underperformance.”
In a recent research report, Hedge Fund-ing the Pension Deficit: The Case for UK Schemes, Cambridge Associates conducted a stress-test analysis of a pension fund bolstered by a 20 percent stake in hedge funds and concluded that it would fare significantly better than one with a traditional investment strategy of 60 percent global equities and 40 percent long-duration bonds if it encountered another market stress scenario such as the Tech Bust in the 2000’s or global financial crisis that took place nearly a decade ago.
This calculation assumed a pension fund with a funding level of 80 percent. According to the December 2016 update from the UK’s Pension Protection Fund, 4,272 funds in its PPF 7800 Index were in deficit, which equals 74 per cent of the total. The last time the aggregate funding level of UK pension funds recorded a surplus was December 2013. The general downward trend—compounded by low interest rates and the rising value of liabilities—has been affected by the volatility caused by recent events affecting the financial markets such as the June 2016 Brexit referendum.
Boardman said: “With rising dispersion within equity markets and prospects for increased market volatility due to ongoing uncertainty following the UK referendum, the risk of contagion in other European countries and diverging global growth prospects and interest rates, the environment is well suited for talented hedge fund managers to add value.”
Putting the “Hedge” Back into Hedge Funds, Long-Term Returns are Compelling
Until recent years, much of the attention on hedge funds has focused on their record for generating significant double-digit returns. Lately, faced with markets driven by changes in Central Bank policies, they have struggled to match their historical performance.
Now, according to Joseph Marenda, managing director at Cambridge Associates in San Francisco, there is growing awareness of the “forgotten benefit” of hedge funds as a risk diversifier in volatile, uncertain times. Originally designed as a hedge against general market fluctuations—hence the name—these funds should allow trustees to smooth returns over time.
It is the potential to limit losses during a downturn that has enabled the best hedge funds to deliver strong performance over the long-term. “Capital preservation during bear markets enables low beta–high alpha hedge funds to capture the long-term benefits of compounding returns,” Marenda explained. “Strategies that may appear volatile in isolation, such as managed futures and global macro, can be strong diversifiers in the context of a traditional scheme portfolio due to their zero-to-low correlation with traditional asset classes.”
In the period from 1 January 2001 through 31 March 2016, the MSCI All Country World Index fell at least 8 per cent on 10 occasions. In September 2002, when the index fell 12.5 percent, a portfolio with a 20 percent allocation to hedge funds would have fallen by 4.6 percent, according to analysis by Cambridge Associates using various indices as proxies for performance. By contrast, a traditional portfolio with 60 percent in equities and 40 percent in bonds would have fallen by 6.9 percent.* “This smaller loss would be valuable at a time when the plan trustees are unlikely to want to contribute additional funds, which they need for their business operations, to the scheme,” said Marenda.
The Decline of the Classic “2 & 20”: A New Willingness to Charge Lower Fees
If low beta-high alpha hedge funds seem attractive from a risk-return perspective, they are nevertheless regarded with suspicion by some pension fund investors who have questioned their high fees. While many hedge fund managers were able to grow their fees to levels of 2 + 20 in recent years because of sustained growth in investor demand, Cambridge Associates has always believed that fees should be more appropriately scaled to the level of real alpha generated by the managers and have been working aggressively to get lower and more aligned fees for clients.
Boardman said: “Investors are right to be conscious about fees in the current low-growth, low-return environment when every basis point matters for the bottom line. In addition, Performance dispersion across hedge funds is larger compared to traditional asset classes—therefore manager selection (only paying high fees to those who can really generate alpha) is critical to ensure our clients have the best fees and terms.”
To ensure the alignment of interest between investors and asset managers, negotiation discussions have been a key focus for Cambridge Associates on behalf of clients. In 2016 alone the firm negotiated terms and lowered fees with over 80 hedge funds around the world.
But Boardman cautioned investors against selecting purely on the basis of fees alone. Historical data indicate that some higher fee hedge funds have outperformed lower fee funds over time. In the 10-year period to September 2016, the top-performing quartile of hedge fund managers monitored by Cambridge Associates charged, on average, a management fee of 2.1 percent and delivered an annualised net return of 9.4 percent. By contrast, the bottom quartile managers charged a 1.3 percent management fee and delivered a net return of 7 percent per year.
The spectrum of high- and low- quality managers is wider in the hedge fund industry than in any other branch of asset management, and Cambridge Associates only recommends about 2 percent of the global manager universe. In the 10-year period to September 2016, the top 5 percent of diversifying hedge fund managers outperformed the bottom 5 percent of managers by an average of 12 percent per year. By contrast, the gap between the best and worst US Large Cap equity managers was 6 percent.
*The Traditional Portfolio is made up of 60% MSCI All Country World Index (Net) and 20% FTSE British Government Over 15 Years Index, and 20% FTSE British Government Index-Linked Over 5 Years Index. The Traditional + Hedge Fund Portfolio is made up of 40% MSCI All Country World Index (Net), 20% CA Hedge Fund Advisory Composite (50% GBP Hedged), and 20% FTSE British Government over 15 Years Index, and 20% FTSE British Government Index- Linked Over 5 Years Index.
For more information and to speak with Trudi Boardman or Joe Marenda, please contact: Simon Targett, Sommerfield Communications at +44 (0) 207 060 6551 or email@example.com.
About Cambridge Associates
Cambridge Associates is a global investment firm founded in 1973 that builds customised investment portfolios for institutional investors and private clients around the world. Working alongside its early clients, among them several leading universities, the firm pioneered the strategy of high equity orientation and broad diversification, which since the 1980s has been a primary driver of performance for these leading fiduciary investors. Cambridge Associates serves over 1,100 global investors – primarily foundations and endowments, pensions and family offices – and delivers a range of services, including outsourced investment (OCIO) solutions, traditional advisory services, and access to research and tools across global asset classes. Cambridge Associates has more than 1,300 employees – including over 150 research staff – serving its client base globally. The firm maintains offices in Arlington, VA; Boston; Dallas; Menlo Park and San Francisco, CA; London, UK; Singapore; Sydney; and Beijing. Cambridge Associates consists of five global investment consulting affiliates that are all under common ownership and control. For more information about Cambridge Associates, please visit www.cambridgeassociates.com.
This press release is provided for informational purposes only and is not intended to be investment advice. Any references to specific investments are for illustrative purposes only. The information herein does not constitute a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual clients. This release is not an offer to sell or the solicitation of an offer to buy any security in any jurisdiction. Past performance is not a guarantee of future returns. Broad-based securities indices are unmanaged and are not subject to fees and expenses typically associated with managed accounts or investment funds. Investments cannot be made directly in an index.
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