The $110 billion Pension Fund Association (PFA), one of JapanÆs leading institutional investors, has mandated Philadelphia-based Hamilton Lane as a gatekeeper for private-equity investments, says Daisuke Hamaguchi, investment director at the PFA in Tokyo.

The PFA has already been investing in Japanese private-equity funds and three foreign funds of private-equity funds. But these latter vehicles have proven too expensive, with an extra layer of fees adding nearly 100 basis points to the PFAÆs costs. ôIf we invest several billion dollars in them, that adds up to a lot,ö Hamaguchi says.

Moreover these funds of funds turned out to invest in the same big mega-sized buyout funds from the likes of KKR or TPG. A pension fund of PFAÆs size is able to meet such firms directly. Also it found itself investing in over 100 general partnerships via these funds of funds û which is too diverse. The PFA would rather concentrate investments in high-quality names and access to teams it canÆt research or contact itself.

Therefore it is delegating new allocations to Hamilton Lane, which accepts a lower fee for its advice. Whereas the PFA has no discretion over what a fund of fund does, it is not giving Hamilton Lane money to invest. Rather the specialist will present the PFA with shortlists from the world of private equity, and it will be up to the PFA whether to invest.

The PFA will continue to use some of its funds of private-equity funds, which remain a simple way to get access across a range of investments, in which money can be quickly deployed.

Hamilton Lane was established in 1991 and now manages $10 billion of private-equity assets as well as advises clients on another $75 billionÆs worth. Its existing clientele includes high-profile institutional investors such as the California Public Employee Retirement System, the Seventh Swedish National Pension Fund (AP7), Temasek, JapanÆs Norinchukin Bank and BritainÆs Royal Mail Pension Trustees.

This shift in private equity is part of a broader expansion of the PFAÆs strategy for alternative investments. It is also introducing new investments in hedge funds and real estate.

Hamaguchi arrived at the PFA in 2005 after running investments for the pension fund of Mitsubishi Corporation. One of his goals was to introduce alternative investments to the PFAÆs portfolio, to both improve returns and reduce total risk. Since his arrival the fund has invested in funds of hedge funds.

Now it has begun using hedge funds as the alpha component of a new portable-alpha scheme. The PFA determines the basic outline of this, using total return swaps for foreign equities or bonds (its beta source) via investment banking counterparties. The PFA cannot legally conduct direct derivatives transactions but swaps are allowed.

It hired investment managers to execute these transactions, in collaboration with its master trust (in this case, the Master Trust Bank of Japan), which is responsible for the Isda and credit enhancement agreements.

Finding equity beta is simple; there are plenty of international managers. There are far fewer bond specialists, so some of these transactions are done with futures against an index, a passive strategy to replicate total swap returns. The PFA has mandated Barclays Global Investors and State Street Global Advisors for both fixed-income and equity beta. They use the physical securities in their passive portfolios as collateral for the swap transactions.

The alpha providers are six funds of hedge funds, which Hamaguchi declines to name; and he also declines to say what kind of total return the PFA expects from its portable-alpha scheme. But he does say the organization is also considering employing single-manager multi-strategy funds.

Lastly, the PFA is evaluating possibilities in real estate. It has a pilot mandate about to launch. ôWe want to test the fundÆs capabilities as well as their desire to deal with us,ö Hamaguchi says.

Real estate has suddenly become accessible thanks to the new Financial Instruments and Exchange Law that recently came into effect. Before, any real-estate transaction done by a pension fund would have to go through a trust bank, but now it is allowed to hire investment managers who specialise in this field.

The law has also spurred local developers to set up investment subsidiaries. This includes the like of Mitsui Fudosan, Mori Building, Mitsubishi Real Estate and Nomura Real Estate, and this is the pool from which the PFA is now piloting a mandate. For the time being it wants to begin with domestic real estate, although if a success, international investments could one day follow.

Tomorrow: Corporate governance amidst poison pills.