Hedge funds forgiven for slump as insurers shun low-yield bonds

LONDON – Hedge funds are being spared punishment for their 2011 performance as insurers that suffered last year with lower-than-expected returns decide they won’t be able to do much better in the bond market.
Policyholder-owned insurer FM Global plans to boost the allocation to hedge funds in its $10.5 billion portfolio this year, after the bets “didn’t really deliver too well” in 2011, said Paul LaFleche, the company’s senior vice president of investments. The funds provide diversification and historically had attractive returns, he said.
Last year’s slump raised the questions, “Are these absolute-return vehicles? Have they outlived their usefulness?” said LaFleche. “The very volatile, whipsaw conditions are what caused hedge funds to produce almost nothing last year. So I think you can get those upper single-digit returns, and I’d much rather put some money there than in fixed-income.”
Low interest rates have pressured results for insurers, which rely on bonds to back obligations to policyholders and generate income. Investment managers at the companies are seeking to maintain portfolio yields as securities with higher coupons mature and the Federal Reserve pledges to keep its benchmark rate low through late 2014.
Overall, clients deposited a net $70.7 billion throughout 2011 in hedge funds as the investment vehicles lost an average of about 5 percent amid swings in global markets, Chicago-based Hedge Fund Research Inc. said last month. Last year’s performance was the worst for hedge funds since 2008, when they sank 19 percent, Bloomberg aggregate hedge fund index data show.

‘Edging Higher’

FM Global currently holds about 2 percent of its portfolio in hedge funds, an amount that’s been “edging higher” and will climb in 2012, said LaFleche. The strategies within the portfolio are selected by asset managers at Morgan Stanley and Goldman Sachs Group Inc., he said.
Insurers have shown interest in high yielding credit strategies such as distressed debt and mezzanine, and macro and tactical trading funds, said Mike Siegel, who heads the Goldman Sachs Asset Management business overseeing $75 billion in general account funds for insurers.
“I don’t think 2011 performance has deterred interest in the asset class,” he said in an interview. “They’re re-looking at their asset allocations across the board.”
Distressed credit managers trade debt of companies or government entities in, or headed for, default or bankruptcy. Mezzanine debt, the layer of funding between common equity and bank loans, tends to yield more than comparable securities because it ranks behind other obligations in the event of default.

Private Equity

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Discretionary global macro managers trade anything from currencies to interest rates and bonds to profit from broad economic trends. Tactical trading refers to strategies that speculate on the direction of asset prices.
Insurers’ holdings of hedge fund and private-equity investments climbed 19 percent to $55.4 billion in 2010, building on a 4.3 percent increase a year earlier, according to the National Association of Insurance Commissioners, which collects information on firms’ U.S. holdings. The association doesn’t yet have 2011 data.
Beazley Plc, a Lloyd’s of London insurer, has about 10 percent of its $4 billion portfolio invested in hedge funds. The company plans to keep its allocation after a “small loss” on the holdings last year. Returns on the investments “compared favorably” with Hedge Fund Research’s fund of funds index, the Dublin-based insurer said in a Feb. 7 statement.

Beazley Comfortable

“We’ve got a ceiling of around 13 percent so it’s sitting close to where the maximum could possibly be,” said CEO Andrew Horton in an Feb. 7 interview. “We’re comfortable where we are.” The insurer keeps the majority of its investment portfolio in bonds such as sovereign debt. Its assets returned about 1 percent last year.
Warren Buffett, the billionaire chairman of Berkshire Hathaway Inc., is among insurance executives who have said fixed-income bets are risky based on near record-low interest rates and the prospect of inflation. The yield on 10-year Treasuries has been below the U.S. inflation rate since May.
“As long as companies keep money tied up in government securities, over time they’re destroying value,” Goldman Sachs’s Siegel said. “That’s troubling to many of these companies, so that’s why you’re seeing the focus on, ‘Where do I invest to get a positive after-tax return on my assets.’”
Hartford Financial Services Group Inc., the life and property-casualty insurer that counts billionaire John Paulson among its largest investors, has been using proceeds from some maturing bonds to boost hedge fund bets. Hartford, based in the Connecticut city of the same name, had $824 million in the funds as of Sept. 30, compared with $435 million three months earlier, according to the most recent regulatory filings.

Low Correlation

Gregory McGreevey, the insurer’s former chief investment officer, said in September that the company was looking to invest in funds that had low correlations with the broad fixed- income and equity markets. The insurer added staff to allocate the investments, targeting discretionary macro funds as well as long-short credit and equity funds, he said at the time.
Hedge funds gained 2.6 percent in January, according to Hedge Fund Research, as equities around the world had the best start in 18 years. The investments may be attractive to insurers because the funds are more liquid than other alternatives to bonds, such as private-equity and real estate, said Daniel Celeghin, a partner at Casey Quirk & Associates LLC in Darien, Connecticut, which advises asset-management firms.
“Their view is, on the margin, if we’re going to reallocate, or allocate away from traditional fixed-income assets, we don’t want to give up too much liquidity,” Celeghin said. “And so you’re left with hedge funds.”

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