Insight - What's the Formula.

(From Financial Director)

Byline: Richard Willsher.

In the quest for higher returns against the backdrop of flat equity markets, pension fund managers are turning to hedge funds in increasing numbers. Consultants Watson Wyatt and Psolve Asset Solutions confirm this trend, though precise numbers are not available for rates of hedge fund allocation.

From among the highly technical and sometimes exotic strategies offered by hedge funds, both firms suggest their fund management clients should choose a 'fund of funds', where they can gain exposure to a variety of investment strategies and hedge fund managers under one overall manager.

The attraction of hedge funds is that they offer active management of funds in an unregulated environment where they are able to apply strategies not open to the conventional fund management industry, such as short-selling and a high level of leveraging. The goal is exceptional returns in exchange for the high level of fees that hedge fund managers demand.

There have been some notable recruits to the hedge fund approach - BT and RailPen among the most noteworthy - but the big question is, is it worth it? Average hedge fund returns as illustrated by MSCI's Hedge Fund Composite Index for the year to date announced 23 July 2004 show between 1.6% and 2.3%, depending on how the index is weighted. Not exactly stratospheric, but as Chris Mansi, Watson Wyatt's head of the hedge fund research team, points out, these are calculations of average performance. Moreover, not all of the 6,000 or so hedge funds in existence reveal the levels of their returns. In addition, the object of the exercise in using hedge funds is to choose skilled managers who can really outperform.

Pension fund managers opting to put part of their portfolio with hedge funds need to be able to know the exact value of their investments at any one time in order to fulfil their fiduciary duties. This, however, has become a hotly debated issue.