For the past several years, low interest rates and a volatile and often-depressed equities market confounded pension plan administrators when it came to the performance of their plans' assets. Naturally, they began to seek out alternatives, and one of the most popular was hedge funds.
According to Greenwich Associates, a Connecticut-based financial services consulting firm, U.S. corporate defined benefit plans had more than $15 billion sunk into hedge funds as of last year, with billions more expected to follow. "In terms of what weathered the bear market, hedge funds are pretty much it," says Meredith Jones, director of market research at Nevada-based financial software provider Strategic Financial Solutions LLC.
Even so, investing in hedge funds poses its own risks for plan administrators, who haven't forgotten the 1998 meltdown of widely touted Long-Term Capital Management: Reliable information on these funds, which remain largely unregulated and secretive, is scarce–and surprises are more than just possible.
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Lucky for the wary pension fund manager, tools exist to help them sort through fund offerings. For example, Strategic Financial Solutions offers PerTrac 2000, software that allows users to import information from hedge fund data providers, such as Hedge Fund Research Inc., InvestorForce's Altvest, HedgeFund.net, CogentHedge.com and Tremont TASS (Europe) Ltd. With PerTrac, a pension fund manager could search for funds that meet specific criteria–e.g. with at least $500 million under management and which have returned a minimum of 10% a year for the past five years.
The databases provide feeds so that investors can get monthly performance information to monitor investments. The software also allows for peer group analysis and Monte Carlo stress testing, which lets investors see the probability their investments have of achieving certain returns, Strategic Financial's Jones explains. "The possibilities are really only limited by the data that is available," she notes.
In February, Ibbotson Associates, a Chicago-based firm that provides asset allocation software, announced plans to add data from Hedge Fund Research to its EnCorr analytical software. It will allow managers to search, sort and analyze hedge funds using more than 20 criteria, including investment strategy, money manager and minimum investment requirement.
If an investor is looking for a particular type of hedge fund–for example, equity market neutral–EnCorr can search HFR's database to find funds meeting that criteria, says Natalie Freedman, an Ibbotson consultant. Since many institutions have rules limiting the percentage their investment can represent of a hedge fund's total assets, the software can also search for funds that comply with specific size mandates.
Once those requirements are met, the software can analyze the funds from a quantitative standpoint, including return, standard deviation and Sharpe Ratio, a measure of an investment's risk-adjusted return. When investors have whittled down their list, they can use the software to search for contact names and phone numbers, Freedman explains.
Deutsche Bank's Equity Prime Services offers a way for hedge funds using DB as their prime broker to give existing fund investors an inkling of a fund's trading style. The service is part of the risk management suite available to hedge fund clients through db RiskOffice.
While specific holdings of hedge funds are not disclosed, the screens could show exposure to certain industry sectors or across asset classes. In addition to the screens, the service offers "traffic lights" to alert investors if a fund's trading guidelines are changed.
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