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Alternatives Attracting Institutional Investors

Despite the Canadian and U.S. equity market returns of 13 per cent in 2003, pension plan sponsors are wrestling with the dilemma of covering their liabilities.

The dilemma is twofold. One, mature Defined Benefit pension plans are looking at increased liabilities as more and more aging workers reach retirement age.

As well, most managers are not all that optimistic about returns going forward. Surveys suggest that pension fund managers anticipate a total return of no more than six per cent in 2004 for a typical Canadian pension fund with 55 per cent of its assets invested in equities and 45 per cent in fixed income. This return would be lower than recent past returns, but is also lower than the 6.5 per cent to seven per cent interest rate generally used for actuarial valuations.

The result is that institutional investors – including pension funds – are looking for ways to enhance returns and reduce overall portfolio risk. They are seeking strategies with little correlation to common asset classes and looking to alternative investments, and not just absolute-return strategies. Currency overlays, private equities, real estate, emerging-market securities, and even commodities – all of which have low correlations to traditional asset classes – are attracting interest.

Research by Greenwich Associates, for example, shows U.S. institutional investors increased their allocations to hedge funds by 36 per cent to nearly $70 billion in 2003 from $50 billion in 2002.

The same research suggests that 19 per cent of investors who currently invest in, or plan to begin investing in, alternative asset classes expect to boost their holdings in equity real estate assets, 23 per cent plan to add to their private equity holdings, and 29 per cent expect to increase their hedge fund portfolios.

The major shift has been out of domestic equities, and that’s a trend which has occurred worldwide.

Among U.S. investors, domestic equities dipped to 46.8 per cent from 49.4 per cent, while alternative investments rose to 7.5 per cent. Their U.K. counterparts dropped investment in domestic equities to 38 per cent from 42.7 per cent the year before, while alternative investments rose to seven per cent from 6.1 per cent.

Among funds that invest in alternatives, hedge funds are attracting the most interest. Indeed, pension funds in the United Kingdom are now investing 6.5 per cent of their total assets in hedge funds.

And while some Canadian pension funds have made the move into hedge funds, many others are still just looking so the asset class is attracting more and more attention.

Given that backdrop, Benefits and Pensions Monitor presents its Second Annual Report and Directory of Alternative Investment Managers.

With all the attention being paid to hedge funds, the report starts with a debate. Clive Morgan, of York Hedge Fund Strategies, tells us why hedge funds are going mainstream on Page 46. Sam Wiseman, of Wise Capital, takes a more cautious approach and offers his reasons for avoiding them on Page 47.

Given the nature of these investments, Shawn Menard, of Russell/Mellon Canada, examines selecting a manager for hedge funds on Page 51 while Helen Steers, of Pantheon Ventures Limited, explores the same theme for investors in private equities on Page 54.

Finally, the Directory of Alternative Investment Managers starts on Page 57.

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