John Dagostino
July 19, 2016
Managing Director and Head of Americas at DMS Governance.

Get Out Your Yoga Mats... Institutional Investors Demand Flexibility

I attended the semi-annual SACRS (State Association of County Retirement Systems) conference recently and thought this summary of pension fund views may be of interest to you or your clients.


The SACRS Conference:

  • 20 California pensions represented (out of ~40 major public pensions in the state)
  • Majority of state pension assets represented at this conference (>1T)
  • CIOs and Trustees attended

Main Takeaways:


Please keep in mind these are observations culled from a fairly small sample set. As always, these are my views and my views alone.


Hedge funds may face increased challenges raising pension assets through pooled vehicles and may need to modify their approach/flexibility, emphasizing co-invest opportunities.

  • Almost all Trustees I polled (19 out of 20 pensions in attendance) stated they were lukewarm to negative on investing directly into pooled hedge funds for 2016/17 (ie allocations will not increase and will likely decrease). Trustees cited:
    • Poor performance/transparency
    • Headline risk (not just related to negative performance but also to fees paid on positive performance)
  • CIOs struggling to get deal flow past skeptical trustees have an easier time selling a customized product, managed account, Fund of One, etc., than a pooled vehicle.
  • Private Equity is viewed very differently than hedge and is not considered "alternative" by trustees. PE presents lower headline risk. Despite the fact that total fees paid to PE can be greater than hedge, they are viewed as less expensive.
  • Emphasis will be on low fee strategies for beta and PE/co-invest with hedge funds for alpha.
    • Pensions are moving away from being "slow sticky" money. They will still maintain long investment duration but are more willing to be nimble.
    • For example, consulting firm and portfolio turnover has increased.
    • To enable flexibility, some CIOs are pushing for "MCA" - Master Custody Account - an umbrella account that the Trustees approve for a given fund complex. The CIO can then trade within that account across the fund complex without having to go back to the Board for approval. This requires the manager to permit liquidity across its products with little to no limitation. This may run afoul of certain MFN agreements despite the MCA having a single beneficial owner.
    • Co-invests are preferable to fund investments due to increased transparency and customization.
    • Credit/yield strategies (>5 years duration ideally 10-15 years) are by far the most sought after.

There is significant gap between how Trustees and CIOs view hedge funds.

  • Trustees and CIOs view the risk and benefits of hedge funds differently, with Trustees focused more on the public relations perception.
  • I asked every pension Trustee and CIO to identify their primary risk/concern with hedge funds:

  • The majority of Trustees cited headline risk as their top concern. Notably, this headline risk is no longer the risk associated with losses/fraud. It is now the general risk associated with a media focus on hedge fund behavior even in positive environments (i.e. Puerto Rico debt, fees paid on positive performance, etc.).
  • Trustees repeatedly requested that the industry try to repair its public image.

Pensions are under increasing regulatory pressure with regards to governance and perceived conflicts.

  • In the US and globally, increased fiduciary requirements are putting both IMs and pension trustees at greater risks.
  • For example, the FCA is requesting that pension funds provide identifying information for both staff and trustees (Board) in certain situations where they are invested in UK domiciled funds and the FCA has deemed their investment a "control" investment. The FCA has not provided a specific % threshold that makes an investment a control investment, but has indicated through the GP that a reduction to less than 10% may not solve the problem. They were not clear whether this meant initiating a 10% position would qualify as control, or whether in this instance a dilution down to 10% would not be sufficient to remove control, given the size or quality of the initial investment.
  • The FCA reached out to the pension fund (through the GP) and requested identifying information for the pension fund's Board. After refusing this request, the FCA notified the GP that their registration status could be revoked unless the pension fund complied. It is not clear whether the implications of this would be an inability for the GP to market the fund further or more serious limitations on trading activity.
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