USS warns hedge fund industry

Hedge fund investors must stop “undermining” one another by accepting inadequate terms, says allocator the Universities Superannuation Scheme, however the $1.9trn industry must also work itself to repair reputational damage inflicted by some of its own during the credit crunch.

The $1.9trn industry angered investors in the crunch with practices such as gating, boards acting for managers not investors, charging fees on locked assets and poor transparency.

Mike Powell, chair of the alternatives committee at the UK’s second largest scheme, said the hedge fund industry must “take greater steps towards repairing a reputation tarnished by the actions of some hedge funds in 2008”.

But he added: “Investors could do much better. Too often we find ourselves in the position of pushing for amendments to a hedge fund’s terms, only to find other investors accepting those terms and undermining our efforts.”

Speaking to Alternatively, a publication from Royal Bank of Scotland’s investment funds team, Powell said investors neither concentrate on, nor understand enough about, fund governance risks, adding: “We are not being compensated for any corporate governance risk we are taking.”

He praised trade bodies such as the Hedge Funds Standards Board for raising industry standards.

But the head of alternatives at USS added: “The onus is on individual investors to demand better standards when considering or reconsidering a hedge fund investment.”

Powell said USS “walked away from managers” who refused governance demands on matters such as treating investors equitably, structures and powers of fund boards, fees, and transparency.

“We will continue to do so, since we believe these demands are fair and reasonable, and we don’t see a reason why they should not agree to…make us a comfortable, and thus more stable, investor and partner,” he said.

“The industry experience of 2008 has helped us get adequate transparency, liquidity and attractive fees as hedge funds now see these as helping keep institutional investors comfortable with their allocations, and maintain a high level of conviction in their strategies,” Powell said.

He said USS interviews board members to assess their ability to “support investors’ rights versus blindly permitting what the hedge fund manager may want, when these interests and outcomes are in conflict.”

Despite Powell’s stern words, USS expects to boost its 3% allocation to hedge funds to 5% over 12 months, and is adding one manager per month.

Powell said the industry’s performance remained “compelling”, despite its losing 19% in 2008. The increased allocation comes as part of USS’s increase in overall exposure to alternative assets from 14% now to a target of 20%.

Of hedge funds, Powell said: “The outlook for returns from risk assets is relatively muted and pension funds will need to find investments that can generate additional value above the modest returns from beta.”

Powell expects pensions’ total allocations to grow as consultants become increasingly comfortable recommending hedge funds.

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David Walker
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