It is finally happening: Hong KongÆs largest pension fund, the Hospital Authority, is allocating up to 10% of its HK$17.5 billion ($2.3 billion) in assets to alternative investment vehicles. This is the first time any Hong Kong-based pension fund has done so û but will it set a trend?

ôOther pension funds could do this,ö says Jimmy Pun, until last month chief manager of finance for the fund. ôThe minimum subscription for some funds is small, as little as $1 million. ItÆs a question of what the fund is comfortable doing.ö

PA mag pic: hospitalsHospitals is not just another pension fund. Unlike most of its peers, Hospitals carries out its own asset allocation, although Towers Perrin provides advice. Pun has built its investment strategy over the past decade, with the emphasis on long-term consistent returns. The overall target is a 4% real return against salary inflation per annum. In fiscal year 1998, when most pension funds were down as low as -25%, Hospital Authority ratcheted up a 12% gain, and reported a 30% return in fiscal year 1999.

ôWe are quite diversified, with a multi-manager structure,ö Pun explains. ôThe secret is not to allow managers to time the market; instead they should just pick the best securities or products.ö

Size matters. Hospitals benefits from a steady cash inflow from its 43,000 members. ôThe bigger asset size you have, the more opportunities you get to diversify,ö Pun notes. The road to alternative investing has been long. In its early years, the fund restricted its investments to large-cap stocks in core markets and government bonds. It gradually expanded, first moving into a broad range of securities, and in the 1990s into other Asian and emerging markets. Pun says there has never been a blueprint about diversifying assets; it has just evolved with the fund. Today, on a regional basis, Hospitals allocates 20% to Hong Kong and another 5% to other Asian markets, with 70% long equities and 30% in fixed-income.

The first alternative product Hospitals considered was property, in 1995. ItÆs a standard investment in markets such as Australia and the United States as a good hedge against local inflation. But the structure of Hong KongÆs property market prohibited any move û itÆs too expensive and HospitalsÆ allocation was too small, and itÆs too much trouble to manage a scattered portfolio of apartments and so on. Furthermore in Hong Kong, property deals are made quickly and privately, requiring an expensive specialist to run an investment. In 1998 the market crashed, killing any lingering interest.

In 1996, Hospitals started researching other alternatives, such as hedge funds. By now its assets under management had reached the $1 billion mark, making it big enough to safely allocate small portions to riskier products. But this process took time, as Pun had to make sure the HospitalÆs trustees understood such investments and their risks. Once the trustees accepted the idea, Hospitals then began to look at specific options, a process that was interrupted by the regionÆs financial crisis.

This year Pun decided to allocate 2.5% from his equities allocation to private equity, and has recently committed to a new fund being raised by Goldman Sachs. ôIt so happened that Goldman Sachs was looking for new subscribers at the time,ö Pun says. ôThey approached us directly. We did our own due diligence and felt they had a good track record. ItÆs a large fund and our commitment is a drop in the ocean. TheyÆre putting in their own money as well, which made our trustees more comfortable about the investment.ö

Hospitals is now looking to allocate another 2.5% to a fund of funds. Towers Perrin is currently evaluating mandates and carrying out due diligence.

Finally, last month Pun mandated UBS Asset Management and US-based Mackay Shields to run an active high-yield fixed-income portfolio. Hospitals will allocate up to 5% from its bond investments into high-yield debt. Its fixed-income strategy has until now been passive, holding G-3 government bonds and more recently Hong Kong dollar debt.

ôWe found government bonds difficult to add value through active management,ö Pun explains. ôWe wanted to add high alpha so we needed a specialist manager. We already have our own currency overlay, so we donÆt want a bond manager to deal with forex issues û weÆd rather have them concentrate just on managing the bonds.ö UBS and Mackay Shields were selected on the basis of strong track records, Pun adds.