Europeans ‘Cooling’ on Hedge Funds, Preqin Claims

Pension funds across Europe are less convinced by the benefits of hedge funds than in past years, according to research by Preqin.

“Pension funds within Europe will be looking for hedge fund managers to respond to their concerns surrounding performance and fees in 2016.”The data firm reported that 30% of European private sector plans had decreased their exposure to hedge funds during 2015. While 31% of those surveyed had increased their allocations, Preqin recorded a net withdrawal from the asset class of $1.9 billion.

At the end of November 189 European corporate pensions had hedge fund investments, Preqin said, compared to 198 in 2014 and 205 in 2013.

European hedge fund investors Amy Bensted, head of hedge fund products at Preqin, said the number of active hedge fund investors among corporate pensions had been falling steadily since 2013.

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“While average allocations to hedge funds of the remaining schemes have risen slightly, they are still far below the global average,” Bensted added.

After the California Public Employees’ Retirement System announced its withdrawal from hedge funds in September 2014, Dutch health care pension PFZW followed suit in the fourth quarter of the year—netting a $56 million profit in the process.

The UK’s Railways Pension Scheme (Railpen) has been phasing out most of its investments to the sector as part of a wide-ranging overhaul of its portfolio over the past few years. While it has not abandoned hedge funds altogether—despite many reports to the contrary—Railpen has scrapped its dedicated silo and drastically reduced its reliance on the asset class.

A spokesperson for Railpen said the pension used hedge funds “on a highly selective basis”. “We do however believe that much of managers’ added value can be captured systematically and much more cost-effectively for our members by what we call alternative risk premia,” the spokesperson added.

Hedge funds have endured a torrid period of performance since the start of 2014, and Preqin reported that 2015 had been even worse: the firm’s all-strategy hedge fund benchmark gained 2.31% in the year to the end of November. “This puts the performance of the sector on track for the worst annual return since 2011,” Bensted said.

Despite the “cooling” of interest from European investors, Bensted said this group “remains an important source of capital to the industry”.

“These institutions represent 5% of all institutional capital invested in hedge funds today, and 26% of all capital invested by private sector pension funds globally,” Bensted added. “Pension funds within Europe will be looking for hedge fund managers to respond to their concerns surrounding performance and fees in 2016; if this happens then we may see a reversal in this trend towards a smaller participation of these pension schemes in hedge funds.”

Those who can, do, and those who cannot, teach, as the saying goes. But investing may be an exception, according to Morningstar’s Vice President of Research John Rekenthaler.

Despite evidence of academics’ poor track records—Long-Term Capital Management’s Myron Scholes and Robert Merton, for example— Rekenthaler’s latest column argued finance and economics professors are not as bad as people think.

“No doubt Irving Fisher flubbed the Great Depression, but John Maynard Keynes navigated it (and the subsequent rebound) very well, thanks much,” he wrote.

Furthermore, Rekenthaler said academic-led fund companies such as Eugene Fama’s Dimensional Fund Advisors and Cliff Asness’ AQR “have not suffered for their PhDs.”

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“No doubt Irving Fisher flubbed the Great Depression, but John Maynard Keynes navigated it (and the subsequent rebound) very well, thanks much.”However, in addition to IQ, market knowledge, and theories, the columnist added professors would do well to have “adaptability, practicality, and flexibility” for instances when economics theories fail.

Quantitative managers with math, computer science, and engineering backgrounds likewise have some gaps.

According to Rekenthaler, quants are plagued with overconfidence. “There’s no money to be made by outthinking the masses,” he wrote. “Being very good gets a quantitative investor precisely nowhere.”

In addition, numerically gifted investors could stray too far from theories, sometimes leaving them in “no position to understand why their models had worked in the past and how that might change in the future,” he argued.

If an investment formula fails, quants could re-run the numbers and modify their models—“a form of blind reckoning”—which does to connect cause with effect.

Finally, quants struggle in game theory, the columnist said, failing to see “second-level concern of interactive effects.”

“The ability to consider others’ actions in forming one’s own strategy is critical to succeeding in multiplayer games—and I suspect, in investing as well,” he said.