Institutional Investor's Alpha Magazine - May 2008 - (Page 18)

Pension Corner Strategies Send in the Clones Swedish pension fund AP7 is turning to hedge fund replication strategies to avoid making headlines. By Katie Gilbert P ublic pension funds don’t like drama. For this reason they often regard hedge funds with a wary eye. Although such investments can generate enviable returns, they can also produce headline-grabbing losses that public plans like Stockholm-based AP7 would prefer to avoid. In 2007, AP7 — the biggest deﬁned contribution fund within Sweden’s pension system — lost some 6.5 million kronor ($1 million) when two Bear Stearns Cos. credit hedge funds suffered huge losses in their subprime “When hedge funds run into trouble, the media risk is quite high,” says AP7 CIO Richard Gröttheim. mortgage portfolios. AP7’s investment had been made through a fund of hedge funds managed by EIM Group out of Nyon, Switzerland. To make matters worse, EIM had also been an investor in Amaranth Advisors, the illfated Greenwich, Connecticut–based ﬁrm that lost more than $6 billion in September 2006 as a result of a bad bet on natural gas. “One thing that we have experienced during the years we’ve been invested in funds of hedge funds is that when underlying hedge funds run into trouble, the media risk is quite high,” says Richard Gröttheim, 48, chief investment ofﬁcer of AP7, which has Skr1.6 billion of its total Skr82 billion in assets invested in funds of hedge funds. “Even though it’s a small part of the portfolio, and even if you have a diverse fund-of-funds portfolio, it can be tough to deal with that issue.” Gröttheim and AP7’s nine-member investment board are trying to harness the beneﬁts of hedge funds’ noncorrelated returns and leave the drama behind. Six months ago they began to reevaluate the plan’s funds of funds, and they decided to look at replacing them with hedge fund replication strategies. Hedge fund clones seek to reproduce the returns of hedge fund benchmarks like the HFRI composite index — a basket of more than 2,000 funds — typically using a combination of index futures on stocks, bonds and other securities. They also charge signiﬁcantly lower fees than do actively managed funds. The approach appealed to the AP7 board, which plans to hire two or three ﬁrms by this summer to manage the replication strategies. The goal: to move AP7’s entire hedge fund allocation from funds of funds into clones by the end of the year. Gröttheim joined AP7 as CIO and executive vice president in 2000, when the plan was created as part of the nationwide pension system reform that Sweden had begun in 1998. Previously head of the monetary and foreign exchange policy department at Sveriges Riksbank, Sweden’s central bank, he spearheaded AP7’s move into hedge funds in July 2002, when the plan hired EIM and Stamford, Connecticut–based K2 Advisors to each manage 2 percent of its total assets in fund-ofhedge-funds portfolios. In March 2006 — before the troubles at Amaranth and Bear Stearns — AP7 put the two ﬁrms on a watch list for possible termination, largely because of disappointing returns on the part of hedge funds in general. In May 2007 the board opted to decrease the plan’s hedge fund allocation to 2 percent and increase its private equity allocation from 4 percent to 6 percent (it was increased again in January 2008, to 8 percent). The bulk of the portfolio is in equities — 52 percent in global equities, 20 percent in Swedish equities and 10 percent in emerging markets. The plan’s 10 percent ﬁ xed-income allocation includes 4 percent in Swedish bonds, 4 percent in foreign bonds and the 2 percent hedge fund allocation. Photo by Markus Marcetic/Moment for Alpha 18 • INSTITUTIONAL INVESTOR’S ALPHA • MAY 2008

Table of Contents Feed for the Digital Edition of Institutional Investor's Alpha Magazine - May 2008

Institutional Investor's Alpha Magazine - May 2008 Contents Letter from the Editor Longs & Shorts Pension Corner: Send in the Clones The Good Guys: Outside the Box Cover Story: Welcome to Oz Interview: The Tipping Point Regulation: When Sentinels Go Astray Strategies: Taking Credit Research Center: The Hedge Fund 100 Book Excerpt: Shoot the Messenger Alpha Bytes: VaR Enough? Unhedged: Commentary: Not Your Father's Activist

Institutional Investor's Alpha Magazine - May 2008

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