Asset Class Research

Investors in Fund of Hedge Funds (FOHFs) often complain that over the long term, FOHFs have captured only a fraction of hedge fund returns but charged an extra layer of fees. As a result, some investors are attempting to build their own direct programs while many others have flocked to larger FOHFs for their perceived safety, especially after the financial crisis.

This survey draws support from both applied and academic research in the field to examine if in fact investors are evaluating FOHFs properly. It further demonstrates how FOHFs might create value which forms the basis of distinguishing one FOHF from another. The survey also elaborates NEPC’s approach to discovering value-creating FOHFs with examples from its own experience. In conclusion, the survey highlights the potential market opportunity for value-creating FOHFs.

In this paper, we examine two topics: the various roles gold can play in a long-term investment program, and why some analysts consider gold unworthy of inclusion in any investment portfolio.

Core real estate can play an important role in a long-term investment program. It can offer diversification benefits, has low historical correlations to other asset classes, provides current income and the potential for capital appreciation, and can be a partial inflation hedge.

There are many compelling reasons for investing in the healthcare sector. Among them are healthcare’s large and growing share of GDP, an aging population, and the emergence of significant healthcare spending in the developing world. Despite these attractive long-term trends, the complexities involved in analyzing changing regulatory frameworks and scientific developments have made the healthcare sector a challenging one for long-biased investors over the last number of years.

In this paper, we will review some of the structural changes affecting the industry on a global basis and outline the unique characteristics of this sector that make long/short equity a compelling way to invest in healthcare.

Developments in fixed income markets over the past several years have intensified the need to re-examine core fixed income portfolios. A confluence of significant events — the subprime crisis in the summer of 2007, the failure of several important US financial institutions in 2008, and the subsequent Federal Government response — set the stage for a challenging market environment. As a result, some fixed income sectors experienced unprecedented and uncharacteristic volatility in 2008 and 2009, as investors faced poor active manager performance, the failure of diversification among bond markets, and severe illiquidity.

Although we could spend pages analyzing these events and their impact on fixed income, in this paper we look ahead to a new investment framework. In doing so, we question traditional investment techniques and embrace an objectives-based approach to bond investing that moves away from a focus on benchmarks in favor of disaggregating the components of core bonds.

Fixed income instruments are essential to institutional portfolios. Through an objectives-based approach, they can play a role in each step of the asset allocation and investment process. We believe that a focus on the roles that different fixed income instruments can provide in a portfolio will enable investors to build more effective investment programs.

Recent market volatility illustrates the shortcomings of absolute return benchmarks in evaluating hedge fund manager performance. By most metrics, absolute return benchmarks behave quite differently from actual hedge fund performance, and their usage obscures the distinction between manager skill and market exposure. This paper recommends an alternative means of benchmarking hedge fund manager performance.

Since the latter half of 2007, a number of significant macroeconomic factors have dominated the global investment landscape.  What started out as a bursting of the housing bubble in the United States turned into a cascading series of events that eventually threatened the entire global financial system in 2008 and 2009.  The following issues lay at the heart of the financial crisis: ill-conceived and poorly constructed financial derivatives products, an overleveraging of consumer and financial institutions, the collapse of the housing market, a slowdown in consumer spending and, consequently, a precipitous fall in employment.  As a result, many fundamental investment strategies based on micro-level analysis of company-specific situations have had their difficulties.  During this time, however, an investment strategy that has differentiated itself — both in terms of producing positive absolute returns and in assisting to diversify the risks of institutional portfolios — has been global macro.

Senior secured direct lending represents an attractive investment opportunity in the current market environment. This is being driven by the imbalance between low supply of capital for middle market corporate borrowers and high demand from these companies. The dearth of available credit from traditional lenders in the space has created a situation in which investment funds with both capital to invest and the proper investment fund structure can utilize strong credit skills to seek total annualized gross returns of 9-15% by investing in a diversified portfolio of self-originated, senior secured corporate loans.

Unemployment, reduced consumer spending, tightened credit standards, and limited available debt have negatively impacted operating income and market price for most commercial properties. Additionally, the reduced valuations have limited the amount of debt which may be refinanced. Core and value-add real estate investment strategies face the headwinds of increasing vacancy rates, declining rents and increasing lessee defaults. The recent cyclical downturn in the commercial real estate market has created a distinct multi-year opportunity for specialists in distressed real estate. However, as the real estate cycle continues to decline, near term performance in the current environment is more influenced by the market conditions (beta or general macroeconomic themes) and less so by the manager’s ability to impact property operations (or alpha).

Distressed investment managers will most likely have an attractive multi-year opportunity set in which to invest as a result of the macroeconomic slowdown and global deleveraging process that has accelerated since the Spring of 2008. Many market participants have moved away from a multi-year period of embracing increasing levels of risk to a more cautious approach. With increasing levels of defaults expected over the next few years due to deteriorating fundamentals, over-leveraged balance sheets and debt maturity schedules, a supply-demand imbalance of capital is likely to continue for a significant period creating market inefficiencies which can be exploited by focused and experienced investment teams. 

Every stable value offering in the marketplace was under pressure in 2008. Whether plan sponsors were aware of it or not, stable value funds experienced events that had been dismissed as unlikely theoretical outcomes.

The current market environment has led investors to reexamine the components of their investment programs, particularly in light of the impact of the credit crisis and its accompanying elevated market volatility.  Hedge funds represent an investment category that has experienced significant challenges, yet we feel they remain an important component of the investment structure for many long-term investors^.

Treasury Inflation-Protected Securities, or TIPS, are U.S. Treasury debt securities whose principal is tied to the Consumer Price Index (CPI). They are possibly the most overlooked and least understood bonds available to investors. This paper, geared toward our defined contribution clients, provides an introduction to TIPS, details how TIPS work, and lays out a case for adding a TIPS fund to the menu of participant investment offerings.

The meltdown of the global capital markets during 2008 generated significant losses for most institutional investment programs. It also caused investors to question the underlying assumptions of many investment strategies and concepts. The poor investment results of hedge funds, hedge funds of funds, and their application in “portable alpha” frameworks have triggered particular scrutiny, as have well-publicized fund blow-ups and episodes of apparent fraud. 

Recent legislation in the U.S. (the Pension Protection Act) and the first phase of U.S. accounting reform (FAS 158) mandate that liability cash flows be discounted at high quality corporate bond yields. These credit yield requirements are at odds with a true financial economics framework for pension management and also result in liability benchmarks that are not investible for matching asset strategies. In the current environment, plan sponsors that used Treasury or swaps-based Liability Driven Investing (LDI) programs experienced large asset gains while liabilities changed only slightly. This relative gain should reverse slowly over time, but Treasury or swaps-based LDI will remain a key component of most matching strategies.

Our frozen plan framework seeks to define what risks are taken along the path to termination, while retaining flexibility for the specific objectives of each plan.