ENPAM, Italy’s pensions and benefits fund for doctors and dentists, has been investing in alternatives since 2001, an asset class that now accounts for 6.9% of the fund’s overall asset base. Its alternatives strategy is centred on volatility, private equity and in particular hedge funds, an area it is now observing closely so as to achieve further diversification. This, alongside greater management efficiency, is the main reason the fund originally decided to invest in alternatives.
Though it is still observing the impact alternatives have as a complement to the traditional investments making up its portfolio, to achieve its optimum levels of diversification, ENPAM says it is veering specifically towards greater concentration on funds of hedge funds. This is because it believes these have good levels of intrinsic diversification based around the asset management companies themselves, their investment strategy and style with respect to the underlying fund and because they are considered efficient, despite the associated high commission rates. ENPAM adds it is still evaluating the possibilities of investing in other alternatives, such as pure hedge funds or hedge fund indices based on their levels of efficiency in relation to the funds of hedge funds.
ENPAM drew up a check list when it embarked on its investments in funds of hedge funds to ensure it achieved the maximum potential they offered. Firstly, it considered the actual management institution itself, particularly the experience, reliability and integrity of individual asset managers. Next, it undertook an accurate analysis of the investment process, taking into account its validity and sustainability in different market scenarios. Risk management methodologies and implementation were observed, with specific emphasis on the impact the funds of hedge funds have on their underlying funds. ENPAM also looked at transparency of asset management and investment processes as well as assessing the performance of funds of hedge funds over certain time horizons. Finally, it looked at how it would keep control over the entire hedge fund portfolio so that individual funds of hedge fund strategies remained complementary and did not dominate.
With the check-list in place, ENPAM was assured it could evaluate the impact each new investment had on the alternatives portfolio in isolation as well as the fund’s overall asset base. It considered special reference models for this purpose, since the models it normally uses for traditional investments are considered inadequate with respect to alternatives.
ENPAM set concentration limits to determine how it could effectively establish the level of diversification it needed within its alternatives investments. Criteria included concentrations per individual fund, investment strategy, geographic sector and management company of the target investment fund.
Traditionally, the asset management companies provide ENPAM with historical records charting the performances of their managers and relative asset allocation activity and ENPAM says this is sufficient to begin its analysis of the levels of diversification it would like to achieve. Considering factors such as style analysis, peer analysis, performance attribution, cluster analysis and correlation allows ENPAM to specify within reasonable safety margins the characteristics of the investments underpinning the funds of hedge funds and the way the various investment strategies might complement each other.
ENPAM says it has thus succeeded in building an alternatives portfolio that effectively encompasses the elements of risk, profit and correlation it believes necessary to improve the efficiency of its overall investment portfolio, whilst avoiding exposure to unnecessary risk that is not compensated for by the financial markets.
ENPAM found itself looking to the foreign investment managers market to achieve its objective of an efficient diversification strategy. This is because a study it undertook of the domestic Italian market found the managers there were too homogenous with respect to earnings trends and risk management. It says Italian managers seem to invest in the same way with regard to both asset allocation and choice of underlying fund. Moreover, many of them offer products that have similar performance and investment characteristics. This has led to a market with a lot of investment managers with extremely high correlation. ENPAM says it will continue to favour foreign managers until the Italian funds of hedge funds manager market develops a greater level of heterogeneity.
ENPAM believes by implementing its rigorous funds of hedge funds policy and by continually monitoring the performance and development of its alternatives portfolio, it will see a notable reduction on the structural risks that are generally associated with hedge fund investments.

Highlights and achievements
No stone has been left unturned in ENPAM’s analysis of funds of hedge funds as the best means of achieving the level of diversification ENPAM is seeking.
The extensive look at wide-ranging criteria of both potential investments and their asset managers will ensure the funds of hedge funds it selects will form a cost-effective, efficient and wholly complementary addition to existing investments.
ENPAM cleverly used the check-list to determine the level of impact investments in funds of hedge funds would have on both the overall asset base and existing alternatives portfolio.
ENPAM’s eventual choice means it has formulated a strategy that easily achieves the levels of risk, profit and correlation it requires for the move to be considered a success. Moreover, its stringent selection criteria and process ensure its new fund of hedge funds will not incur any unnecessary exposure to risk that cannot be dealt with in the financial markets.
ENPAM’s avoidance of the Italian funds of hedge funds market, which it considers too homogeneous with respect to products available and manager style, whilst it fully exploits the international market, shows the fund has a clear understanding of the hedge funds industry that will serve it well in its plans for further alternatives expansion.

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