PAAMCO Perspectives

Tailored and Transparent: The Key to Absolute Return Funds Under Solvency II


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In the search for attractive and diversified returns, European insurance companies have generally dismissed absolute return funds as potential investments due to lack of familiarity, the complexity of understanding risk and return drivers, implementation hurdles, and the potential for a skeptical regulator particularly in the context of Solvency II. According to a recent Preqin study1 of more than 5,000 global institutional investors, insurers represent just 4% of all institutions invested in absolute return funds. Moreover, those that do invest in absolute return funds allocate only a small portion of their assets into such funds, an average of 3.3%. For Europe specifically, these figures are likely to be lower.


Assessing Risk of Private Equity – What’s the Proxy?


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Asset allocation is perhaps the most important choice facing CIOs. It involves evaluating the risk/return profile of various asset classes and is usually based on a combination of forward-looking expected returns and risk measures derived from historical data. In this context, the traditional modeling of private equity is subject to significant drawbacks. Available index data for private equity is lagged, smoothed, and understated with respect to the beta, volatility, and correlation with public equities. These drawbacks can have a significant impact on portfolio allocation decisions when a large share of a portfolio is allocated to private equity. The purpose of this paper is to evaluate alternative methods to proxy private equity investments in the context of portfolio allocation. This assessment draws on PAAMCO’s experience in managing hedge fund portfolios, which may contain private equity positions.


The Upside of Transparency and Control


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This paper examines how institutional investors can most effectively take advantage of hedge fund transparency and investor control structures. It is written in three parts. The first part of the paper traces the evolution of improved hedge fund transparency and control structures, particularly in the wake of 2008, initially as a defensive mechanism and, later, as a potential toolkit to generate upside. The second part addresses practical issues: now that the toolkit of transparency and control structures is in place, what are some of the “levers” that can actually be pulled to generate benefits for a hedge fund portfolio? The third part looks at how institutional investors make partnerships with hedge funds work.


Funding Gap-Driven Investing (FGDI)


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Market participants have generally come to interpret the concept of Liability Driven Investing (LDI) as being equivalent to Liability Matching Investing (LMI). This interpretation is one that is forcing more and more pension plans to make decisions that do not make economic sense – decisions that may damage the ability of ostensibly well-funded pension schemes to deal with future events with respect to liability valuation or a downturn in markets. In addition, the total value of U.S. defined benefit pension assets is about 3.5 times the USD investment-grade long duration bond market making execution of LDI or LMI initiatives difficult. This article proposes an alternative to the LDI approach: investing not with a view to match liabilities, but with a view to explicitly minimize a funding gap (or maximize a surplus). This approach, which we call Funding Gap-Driven Investing (FGDI), also incorporates the use of assets other than long duration fixed income securities. The aim here is that diversification of return opportunities should lead to greater stability in long term returns as well as greater scope for active management to add alpha in order to provide greater absolute return.


’40 Act Daily Liquidity Hedge Funds: Considerations for Institutional Investors


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With the mounting hype surrounding the growth of the ’40 Act1 hedge fund industry, many institutional hedge fund investors are evaluating whether to utilize a ’40 Act structure for their hedge fund investments or to stay with the traditional private placement structure.2 To assist the institutional investor in making this decision, this paper assesses the risk and return profile of the ’40 Act structure that has daily liquidity, also known as the mutual fund structure, relative to the traditional private placement structure. The paper also discusses the relevance of other features of the ’40 Act mutual fund structure for institutional hedge fund investors to consider.


Under the Hood of Hedge Fund Leverage


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One of the key differentiators between hedge funds and other investment vehicles is the use of leverage. Leverage can be your best friend one day, and your worst enemy the next. Everyone knows that leverage will accentuate both gains and losses. However, less is known about how hedge funds actually obtain and incorporate leverage into their portfolios and how investors should monitor a hedge fund’s use of it.