In Depth

Q&A: Pushing Portable Alpha

Dec 6 2007 | 11:27am ET

While few can deny the emergence of portable alpha strategies as a viable alternative investment product, one fund of hedge funds is looking to make it a mainstay in pension plans’ portfolios.

FINalternatives recently spoke with Bob Kulperger, vice president of Toronto-based Northwater Capital Management, about the emergence of portable alpha strategies and why he thinks they're here to stay.

FIN: Could you talk about the firm’s early efforts to introduce portable alpha to pension plans?

Kulperger: In those first five years, from 1998 onwards, it was initially very difficult to get a meeting on portable alpha, because it seemed to pension plan staff like such a new and complicated approach. However, after the bear market in equities from 2000-2002, it appeared that plans were more willing to hear about new ideas to get themselves out of the same old 60/40 mix that had served them so poorly during the previous few years.

Since 2003, the receptivity for portable alpha has been much better as evidenced by both the increase in the amount of meetings we’ve had and the amount of plans willing to consider and invest in the approach. Moreover, during that time, a lot of consultants have taken an in-depth look at the approach. They’ve had their research teams really dig into portable alpha and they’ve been more comfortable educating their clients on it.

As a result, Northwater’s business grew steadily to its present level of approximately US$9 billion in assets under management including US$4.7 billion in our fund of hedge funds, almost all of which is used in a portable alpha approach. As a firm, we therefore consider ourselves a portable alpha and structured solutions firm rather than a stand-alone fund of hedge funds shop.

FIN: Are pension plans now more accepting of portable alpha strategies, or are they still taking a wait-and-see attitude?

Kulperger: You’re seeing major announcements by pension plans like General Motors and Boeing that they’re taking down their equity exposure significantly, potentially increasing their bond allocation for liability-matching purposes, and combining that bond exposure with a much greater investment in alternatives, often through portable alpha. The small basket that used to be called “other” or “alternatives” is becoming larger every year.

Some pension boards are still nervous about areas of the alternatives market where they don’t have experience. Some of them have not yet accepted hedge funds and some boards are still early with respect to their education on derivatives, but we see acceptance of both of these areas increasing significantly over time.

FIN: What is the makeup of your investor base?

Kulperger: Our client base is 98% institutional, consisting of large defined-benefit plans, along with endowments and multi-employer plans. Approximately one-third of our revenue is still generated from Canada with the other two-thirds in the U.S. and overseas, including the U.K. and Australia. Northwater has a smaller number of investors than other fund of hedge funds shops, but the mandates tend to be larger and the relationships deeper because of the customized aspects of these mandates and the need to share information with the clients. The size of the investors is on the larger side and the average mandate is in the nine-figure range.

FIN: What is your outlook for the use of alternative products among pension plans?

Kulperger: Institutional investors and consultants are starting to blur the lines between traditional and alternative investments. For example, a plan might try to add value to equities through the use of 130/30 and yet you have leverage and shorting in 130/30. So is that alternative or traditional? In portable alpha, you have traditional index market exposure through the derivative combined with hedge fund exposure used to add alpha above the market, which makes it a sort of hybrid of traditional and alternative exposure similar to enhanced indexing. The label starts to become less important than the effect on the plan.

We think five years from now defined benefit plans will look very different than they do now. As a firm, we talk internally about the death of 60/40 and how much better this will be for plan sponsors and their consultants. Allocations will look more like endowments and foundations with respect to how many asset classes they’re invested in and we’re enthusiastic about that as a firm because it plays to our strengths. It also gives us reason to be optimistic about the future of defined benefit plans when this sort of flexibility starts to take hold.


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