First, the good news. A bfinance survey covering a diverse group of pension funds shows that 70% of respondents feel they are getting good value for money from their passive equity and fixed income managers.

Now for the bad. At the other end of the spectrum, a majority of respondents (60%) are disappointed with the fees they pay for actively-managed FoHFs. In the wake of the credit crunch and dramatically changing capital markets landscape, participating pension schemes were asked to rate whether they get good, fair or poor value for their money across 14 asset classes. Not one said they get good value from FoHFs and only 40% say they get fair value.

The survey, conducted in December of 2008, is the first of its kind in one of the most turbulent periods for investors. It covers 10 countries and 32 pension schemes, both corporate and sovereign, with an average AUM of €5.4bn. The minimum AUM among the participating schemes is €250m while the maximum is €37bn.

The largest group of respondents are located in the UK (43%), followed by Germany (21%) and Canada (15%). Sweden, the Netherlands, USA, UAE, Finland, Denmark and Portugal are the other countries represented in the survey.

A key finding shows very different views between asset managers and pension funds on the issue of trading a longer lock up period for lower FoHF fees. A majority of surveyed schemes (55%) favour lower fees from their alternative managers without conceding to a one, two or three-year lock up in exchange for a 10%, 20% and 30% discount. Still, a solid 45% of investors say they are willing to consider trading off liquidity against a reduction in fees.

If asset managers are more willing to negotiate on this issue, it is largely because they want to better manage liquidity within the portfolio. In a separate survey, bfinance asked asset managers if they would consider offering a discount to investors if they agreed to a lock up. The expected decline in FoHF fees could accelerate if the lock up is at least two years. Indeed, 68% of money managers say they are prepared to offer a discount if the investor agrees to a two-year lock up compared to 46% for a one-year lock up and 79% for a three-year lock up.

Not so fast. There do not seem to be many takers among the surveyed schemes. “In the past, we were in actively-managed FoHFs with a one and two-year lock up,” says Richard Grottheim, CIO of AP7. “Liquidity is one reason why we have been migrating out of FoHFs and into FoHF replicators. I would like to have the possibility of quick withdrawal in times of crisis.” Grottheim’s exit reflects the break in trust between pension funds and FoHFs which some believe have failed to sufficiently deliver their multiple objectives of de-correlation, diversification, lower volatility and absolute performance. AP7 has increasingly turned to alternative beta strategies such as hedge fund replicators. “As a rule of thumb, investors paid 2 and 20 for a FoHF. Replication strategies cost less than 75bps. Since last summer, our FoHF replicators have been performing in line or better than FoHFs.”

This may help explain why FoHFs bear the brunt of investors’ dissatisfaction in our survey even as they have outperformed actively managed equities. Indeed, equity index returns largely underperformed FoHFs during last year’s stock market rout. Yet the expectation bar for FoHFs was clearly higher, one reason why they may be ill-perceived amongst pension schemes.  

More investors feel they are getting good (27%) or fair (42%) value for their money from active long-only managers. Even single hedge funds, which have never professed the diversification benefits of FoHFs, fared better. Overall, a majority of investors feel they are getting value for money from their managers; there are, however, wide dispersions: investors have a particularly high level of disenchantment with GTAA mandates which received the highest (86%) number of poor votes.

We note here that a number of alternative strategies and asset classes, among them GTAA, have a relatively low weighting in pension portfolios. Investors were also asked how recent market events would impact investors’ portfolio structure for each asset class. The responses seem to confirm our findings from an earlier study that pension funds are likely to increase their allocations to alternatives (GTAA, private equity, infrastructure, FoHFs, hedge funds) and to turn more passive in traditional asset classes such as equities and fixed-income.

The death of alpha (and its pursuit) is clearly premature. One pension fund, a European auto supplier, recently allocated funds to a GTAA mandate, taking advantage of a lower fee structure. “What we saw in 2008 is that active managers had certain benchmarks to beat and they failed,” says the CIO of the pension scheme who spoke on the condition of anonymity. This broad failure has given pension funds more leverage to negotiate fees down, he notes. “We conducted our search for a GTAA mandate in October and already fees were coming down rapidly. I am paying a base fee of 1% for GTAA and not worried about the performance fee because we don’t think the manager will meet or exceed his Euribor + 3% target."

FoHFs are doing more than just slashing fees (in the case of Renaissance management fees have been waived after a loss of 12% last year), notes the CIO. FoHFs are also reducing their minimum required volume. “In 2004, the minimum volume for FoHFs was €20m. Now it is €5m. I am only paying 70bps for a FoHF with 50 underlying funds compared to 1.5-2% several years ago.”

The traditional 2 and 20 model of a 2% flat fee and a 20% performance fee is unlikely to survive last year’s market bloodletting. Our respondents have been negotiating hard with their asset managers to reduce fees. Survey results show that the priority of pension funds is first to pay a lower base fee. A medium-sized pension fund of a Scandinavian insurance company has been negotiating to reduce both base and performance fees on assets that it cannot redeem because of gate restrictions. “These have been extraordinary conditions which warrant gates,” concedes the CIO of the Scandinavian insurance pension scheme. “However, we have asked to not pay fees on those investments that we have been blocked from redeeming until the next gate period. So far, we have not had any success, but we expect to.”