EURO ZONE: Taking the boot to funds of funds

There have been a number of interesting people moves of late, but one in particular really caught the eye.

Seth Lieberman, a veteran real estate professional most recently at UBS in London, has joined Italian alternative asset manager Advanced Capital as chief investment officer for the firm's new global real estate fund of funds.

It is a significant appointment given Lieberman's strong reputation in the industry. He was previously a principal of the Praedium Funds, a group of opportunistic property investment funds associated with Credit Suisse First Boston.

The hire is evidence of a growing appetite for consultants who can help institutional investors pick the right GPs. It is, however, a trend not appreciated by David Swensen, head of Yale's $17 billion endowment. He told the Wall Street Journal recently that funds of funds and consultants are bad for the investment community and “facilitate[d] the flow of ignorant capital.”

Swensen went further still, telling the newspaper that in relation to funds that direct capital into hedge funds: “Fund[s] of funds are a cancer on the institutional world … The best managers don't want fund of funds money because it is unreliable.”

Surely rather harsh? After all, not every institution wisely wishing to diversify holdings into private equity real estate and other alternative assets classes can afford to employ the 20 to 25 in-house investment professionals that Yale does.

How on earth is the single investment officer at a small local authority pension fund supposed to choose the best managers in the world or access the best in class in all those different regions?

Take the London Pension Fund Authority (LPFA), for example. Albeit the largest local government pension scheme in London, LPFA manages £2.5 billion ($3.7 billion; €2.8 billion) of members money, not the $17 billion that Yale does. It is little wonder LPFA doesn't employ such a large roster of investment experts.

Yet the London Pension Fund Authority rightly decided to diversify holdings by having an exposure to global real estate. Is the investment director Vanessa James supposed to travel the world and interview each and every fund manager in the US, Asia and Continental Europe and select the best private funds as well as equities likely to perform well?

No. Instead, she held a beauty parade of global funds of funds and picked ING's Global Osiris, committing £150 million to it.

As far as the London pension fund is concerned, that is a job well done. It will not be making any more commitments to real estate funds – be they funds of funds or otherwise. To her mind, James has selected the best fit in terms of a manager she thinks has global coverage with capacity to do the work for her.

For this, she is prepared to pay the fund of funds a fee in full knowledge that the underlying fund managers are also charging fees.

There is still appetite among pension funds and other long term investors to access the world's real estate markets and the best fund managers in any given region. For European pension funds that generally don't have the resources of Yale or any of the other large US endowments, they should not feel ashamed of investing with funds of funds.

For their part, funds of funds know they are providing a service and helping open up the market further to diversified pools of capital.

That cannot be a bad thing and should not be denigrated. The approach should certainly not be called cancerous.

While we are pointing fingers, it is only fair to take a look at Yale's recent performance, which is nothing to be crowed over. According to Yale's president Richard Levin in a letter to alumni in December, the fund's investments had a negative 13.4 percent return from July through October.

Levin expects the endowment to remain flat through the 2009-2010 academic year and resume growth after 30 June, 2010. Against that backdrop, the endowment shouldn't be putting the boot into others.