Many European pension funds shunned hedge funds and alternative strategies after the financial crisis, but they may return to favor according to Cerulli Associates, the global analytical firm.

The Cerulli Edge—European Edition, 4th Quarter 2014 issue said that improving performance from alternative strategies together with poor returns from traditional investments means that European funds may eventually review their allocations.

“Just getting past the door seems an impossible task because hedge funds appear to be largely off limits – although the United Kingdom and the Nordic region are notable exceptions,” Cerulli added. “As creditably as alternative funds have performed – and their recent risk-adjusted numbers have been healthy compared with the major equity indices- Europe’s institutions have good reason not to invest in them which extend beyond pure returns.”

The lack of understanding by trustees, regulatory pressures, and headline risk all mean that it may be easier for pension scheme to avoid hedge funds.

The head of global pension solutions at one of Germany’s five largest institutional asset managers told Cerulli that he will not sell non-transparent products like hedge funds to clients.

Cerulli said: “He adds that this would simply present difficulties to the trustees or supervisory boards. When managers with both mainstream and alternative strategies face pension clients, this should not be determining factor, but it often is.”

The report detailed a similar story from a consultant in Holland who said that Dutch pension schemes will buy private debt and bank loans and even infrastructure and private equity, rather than hedge funds, because of governance issues.

The report said: “He cites an example of board members being stumped when the central bank, De Nederlandsche Bank (DNB), paid them a visit. It asked them to explain what their chosen hedge funds did—but they were unable. Then, they were strongly advised to redeem, saying it made no difference whether the fund was Ucits compliant.”

The head of distribution for an alternatives boutique in Germany told Cerulli that pension funds had redeemed complex strategies and invested in peripheral European bonds instead because they did not want to see press reports that they were putting public money at risk.

However Cerulli did see some light at the end of the tunnel for hedge funds. The head of distribution at one German manager told Cerulli that pensions have lowered their required rate of return to between 2.5% and 3.5% a year from the old standard of between 8% and 9%.

“If core debt yields at the heart of pension schemes in Europe remain as abysmal as they have been, pensions will ultimately have to look elsewhere. Hedge funds will, however, be just a side course on their menu,” said Cerulli.

The report said the solution for hedge funds is to continue to emphasize risk-adjusted performance and to launch onshore, Ucits-compliant variant of funds.

“In general, it is hard to avoid the conclusion that pensions without any hedge fund or alternative exposure will deliver poorer long-term outcomes or more volatile portfolios to their end clients,” said Cerulli.

However this month, PFZW, the Dutch pension fund for the health and social sector, said it has eliminated its hedge fund investments over the last year and they will not be included in the scheme’s new investment policy. The pension fund managed €156.3bn at the end of September last year.

The pension scheme said in a statement: “All investment categories are assessed for their sustainability, complexity, costs and their contribution to PFZW’s objective of index-linking pensions. The hedge fund investments were found not to fully meet the criteria set.”

In 2003 the pension fund was one of the first in the Netherlands to invest in hedge funds in order to diversify its portfolio.

Jan Willem van Oostveen, manager financial and investment policy at PFZW, said in a statement: “With hedge funds, you’re certain of the high costs, but uncertain about the return.”

In addition to the high compensation and complexity at hedge funds, PFZW said they often have little concern for society and the environment. The pension fund is switching the 2.7% allocation for hedge funds it had for 2013 to its equities strategy.

In the US last year the giant California Public Employees’ Retirement System, seen as a barometer for pension schemes, said it would eliminate its $4 billion hedge fund portfolio to reduce costs and complexity.

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