Stockholm (HedgeNordic) – The hedge fund industry has had a tough time in the past several years, which prompted some large institutional investors such as pension funds to cut their investments in hedge funds. According to Claudia Stanghellini (pictured), AP3’s Head of External Management, the pension fund has decreased its allocation to hedge funds in the past few years but retained investments in high conviction names. These names provide top research and serve as valuable sources of information for AP3.

AP3 is one of five reserve funds tasked with protecting the Swedish public pension system for current and future pensioners through responsible investment and management of the pension buffer. Asides from their shared mission, AP3 also shares the same investment rules as AP1, AP2, AP4 and AP6, which define clear holding thresholds for specific asset classes. However, within those parameters, each of the pension funds is free to allocate funds as it pleases.

Alternatives, Absolute Return and Correlation

“AP3 has been invested in the absolute return space from 2007. From the start the allocation consisted of internal strategies and external strategies,” Stanghellini explains, discussing the portfolio that covers alternative investments.

“The main goal for the absolute return portfolio is to deliver positive returns over time with low correlation to major markets, especially the equity market. It is therefore important to choose strategies with low correlation to each other and low beta,” the Head of External Management says.

Manager Selection, Conservativism and Partnership

There is a clear division of focus between the absolute return strategies that the pension fund manages internally and those that it delegates to external managers. “AP3 manages long-short equities, long-short currencies in-house. External managers look after CTAs, global macro, long-short credit, emerging markets and volatility strategies.”

Manager selection focuses on quality external managers that can offer the pension fund a wide range of services. “Following several tough years for the hedge fund industry, AP3 currently has a conservative allocation to external absolute return strategies,” says Stanghellini. “In the last few years, we have decreased allocation to hedge funds and retained high conviction names, which also provide AP3 with top research, macro outlooks that can be shared internally, portfolio construction capabilities and trading ideas.”

As of February 2019, AP3 had a 4.3 percent exposure to absolute return strategies, the smallest of its portfolios. The rest of its assets are distributed among long Equities (46.4 percent), Fixed Income (18.8 percent), Credits (4.5 percent), Inflation (25.4 percent), and Currencies (20.8 percent).

“We work with our external managers in partnership. Costs are also an important area for AP3 and preferred managers are those with cost-effective approaches that are sensitive to AP3’s needs and interests,” the head of external management explains. “Given the above considerations, our allocation to external absolute returns strategies is long-term, and the portfolio turnover quite low.”

Volatility Managers and Internal AI Solutions

Given ongoing financial developments, AP3 has renewed its interest in tackling volatility. “AP3 has been invested in volatility for a long time, and the volatility space has been one of our most successful allocations over time,” she says. “We are currently looking at ways to diversify our current exposure and thus looking into possible new candidates.”

“Development of Quant strategies (including some innovative approach and modelling within AI) has been brought in-house,” Stanghellini adds. “We think this is a very interesting area that is possibly going to grow in interest in the future and so we have developed internal capabilities to handle it. Results are promising, and a couple of strategies are already up and running.

Small Caps and ESG Up Ahead

Going forward, the head of external management is looking to focus on managers specialised in less liquid markets and sustainability. “We are in the process of searching for traditional long-only active small-cap managers for both Europe and North America. We are also looking for ESG integrated strategies, as this is very important to AP3,” Stanghellini explains.

“We have met many interesting managers and come a long way in both searches, and we expect the exposures to be in place within six months from now. This will certainly keep us busy for the rest of the year and possibly beginning of next year,” she concludes.

The article was originally published on Ekonamik.com