Block also questioned whether alternatives really were diversifiers. “In my mind, hedge funds of funds (FoFs) have clearly missed a golden opportunity in Australia because of recent performance. “Clearly, they are correlated with equities, thus exploding the ‘uncorrelated’ myth. At least traditional longonly equities performed in line with expectations. “Hedge FoFs claimed a volatility of 4 per cent and exhibited returns of 30 per cent below benchmark – some seven or eight times expected drawdowns. “The experience is similar with other alternatives that promised high returns and no correlation with equities.” Counterparties and investment engineering have been severely hampered by the financial crisis. Block said that funds should look at aggregated exposures.

“After all, if one holds bank bills, shares, corporate bonds and swaps with the same organisation then there can be a very large, but often not measured or managed, exposure to that organisation. Custodians are not yet well advanced in providing funds with global exposures.” Passive managers tended to be the big winners because of the scrutiny on counterparties. Operational issues Unit pricing and other administrative concerns tend not to be front of mind for super fund executives or even funds managers, except when something goes wrong. Currency issues, when coupled with the increasing use of alternatives, have posed challenges for administrators and custodians. In fact, while unlisted assets make up on average about 8 per cent of a typical super fund’s portfolio, they can take up to 80 per cent of a custodian’s effort in pricing, according to National Australia Bank’s Ray Lester, director of delivery services for Asset Servicing.

“Are people taking into account valuation risk in their decisions?” he asked. “Custodians have policies in place but valuation risk is something which everyone needs to take on.” Lester said that about 2.5 per cent of asset servicing’s prices are not independently assessed, but, rather, are sent to the custodian by the fund. There is no industry standard for ex-pricing. With some securities, such as CDOs and CLOs, the valuations are performed by the same people who created the security. “Is that appropriate?” Lester asked. “It’s the client’s responsibility to understand the nature of the asset invested in and the valuation policies being followed.” With currency hedging over unlisted assets and other alternatives, revaluation frequency and underlying currency exposures are important, according to Ross Blakers, associate director of Access Capital Advisers.

He said currency hedging programs needed to have clear objectives, be designed to work at the whole portfolio level, be designed to withstand stress testing and have strong risk management controls. With alternatives, the investor needed to be extra mindful of liquidity issues, however, longer-dated instruments could be used because the underlying investments were generally longer-term. Currency hedges tend to vary between one-month and six-month contracts, using short-term FX forwards for the greatest liquidity and lowest transaction costs. If longerdated hedging instruments are used, say beyond three years, typically cross-currency swaps are more common. Blakers said that while “the longer the duration the better” was a general rule, there were important caveats: credit risk; instrument types (forwards versus swaps); and costs.