Analysis: Big British local authority pensions step up hedge fund bets

By Maiya Keidan, Carolyn Cohn and Simon Jessop

LONDON (Reuters) - From Essex binmen to Liverpool councillors, government pension schemes in England and Wales are investing more in hedge funds whose bets, sometimes dictated by algorithms, have included exotic holdings such as Puerto Rican debt.

Those running local authority retirement pots have been reluctant to advertise their hedge fund holdings, but a Reuters survey reveals that the value of such investments by the 10 largest schemes in England and Wales rose by a third to 2.2 billion pounds ($2.9 billion) in the year to the end of March.

This backing for an industry which some investors criticise for its high fees and relative lack of transparency has led some finance experts to warn that hedge funds expose the pensions of ordinary people to risk and volatility.

"Diversification is good but if you are overstretching for yield and take too much risk, buyer beware," Peter Hahn, professor at the London Institute of Banking and Finance, said, citing the problems experienced by local governments which deposited funds with Icelandic banks before their 2008 collapse.

In their quest to get better returns for their members during a period of low yields in bonds, assets invested in hedge funds at nine out of the top 10 schemes analysed by Reuters rose during the period, in part due to performance gains, while three pension funds added new hedge fund managers and none were dropped, the Reuters survey found.

The 10 schemes - which control around 100 billion pounds of the 259 billion pounds within Local Government Pension Schemes (LGPS) in England and Wales - had 2.3 percent of their assets allocated to hedge funds in the year, up from 2.1 percent a year earlier.

Schemes in England and Wales accounted for almost 10 percent of Britain's total pension fund assets at the end of 2016, a report from Willis Towers Watson shows.

While a direct comparison with investments by other pension funds is not possible because most are not required to give the same level of disclosure, several funds, such as Rhode Island in the United States and British Rail, have reduced their hedge fund exposure or dropped it entirely.

But just one of the 10 funds analysed - Labour-run Greater Manchester - said it had no hedge fund investments. Six out of the nine schemes where hedge fund assets rose were controlled by the left-wing Labour party, which is the main UK opposition.

"Our longstanding view is that hedge funds are far too expensive, insufficiently transparent (despite recent improvements) and do not appear to provide the sustainable returns required," a spokeswoman for Greater Manchester said.

ALTERNATIVE APPEAL

For Chris Rule, chief investment officer of Local Pensions Partnership, a tie-up between London Pension Funds Authority (LPFA) and Lancashire, hedge funds appeal because they offer an alternative that is not tied to mainstream investments.

"What we are looking for is something that is independent," he said. "It may do badly (and) it may do well, at different times. The critical thing is it doesn't move in lock-step."

For the purposes of the survey, Reuters defined a 'hedge fund' as either a fund that charged a performance and management fee or was described explicitly as a hedge fund, although the schemes were often reluctant to do so.

LPFA added three investments in hedge funds in the 12 months to end-March, in Winton Capital, GSA Capital Partners and Graham Capital Management, amounting to 213.5 million pounds. All three hedge funds declined to comment or did not respond to requests.

The new LPFA investments were all in computer-driven funds that follow market patterns, trends or momentum -- a strategy that also appeals to Merseyside, which invests in Winton too.

New investments from other pension funds this year included a so-called 'fund of hedge funds' that invested in other hedge funds and an emerging markets strategy.

Reports by the local government pension funds in the Reuters survey show that total assets in the schemes rose 21 percent to 97.8 billion pounds in 2017. Much of this is accounted for by gains in the value of investments, due to rising stock markets.

"Part of it is that equities have had such a good run over the last 10 years, LGPS are traditionally very big equity owners and looking to take profits and looking for alternatives elsewhere," said Colin Cartwright, partner at consultant Aon Hewitt. "One of those alternatives will be hedge funds."

"Hedge funds are something that provide a different return stream to equities. They should provide some sort of diversification, especially if markets get choppy from here."

West Midlands, the second-largest LGPS in England and Wales, had five investments in hedge funds at end-March 2017, up from four at end-March 2016, but did not respond to requests for comment on asset size and therefore their assets could not be included in calculating the total investments.

Other pensions included in the Reuters analysis were Essex, Lancashire, West Yorkshire, Tyne and Wear, South Yorkshire and Hampshire.

($1 = 0.7491 pounds)

(Reporting by Maiya Keidan, Carolyn Cohn and Simon Jessop; editing by Alexander Smith)