Super funds can bypass hedge funds

Superannuation funds need to find a new way that will offer them access to the alternative source of returns but with the option to bypass hedge funds, US-based fund manager, Parametric says.

According to the company, super fund trustees had become uncomfortable with opaque ‘black box’ hedge fund structures but would still need a new way to access hedge fund-like alternative returns.

Parametric’s research aimed to show how the super funds could use an alternative risk premium to generate a return that was more transparent than hedge fund strategies.

The Volatility Risk Premium (VRP), an alternative source of return, exploited a characteristic in equity option markets both in Australia and overseas where option buyers (buying volatility protection) were to overpay option sellers (selling volatility protection), relative to what the protection was actually worth.

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The report’s authors stressed that the Australian Prudential Regulation Authority (APRA)-regulated funds were typically investing in option markets to buy protection or upside participation, paying an expensive price for these option premiums.

“By becoming a seller rather than buyer, the fund can receive as an income source, rather than pay away as a cost, the VRP. Funds should exploit their ability to be on the more lucrative sell side of these transactions,” they said.

“Once a fund makes the decision to be a seller and harvest the VRP, they don’t need a ‘black box’ hedge fund to implement this strategy.

“The portfolio we designed strips away the trust structure, designs straightforward implementation rules and follows these rules in a systematic, repeatable way. It is also liquid, contains no leverage and is fully collateralised as a self-contained solution for a fund.”

The report also noted that hedge funds were causing some difficulties for super funds as their returns had been low in recent times and on top of that, their typical opaque ‘black boxes’ nature of strategy, complexity and risks was visible for trustees.

“Although the first is market related and could turn around, the second problem is structural and cannot be wished away,” the report concluded.

According to Parametric, APRA-regulated funds typically had about two per cent of their portfolios allocated to hedge funds and used hedge funds to diversify risks away from equities and fixed income.