1. Pension Fund Investments in
Activist Hedge Funds
– Ensuring Accountability Across the
Investment Chain
Workshop 2/3
EC Restructuring Forum 6 July 2010
1

2. Activist hedge funds
Workers’ capital
Pension fund investment in private funds
Accountability across the investment chain
2

3. Private pool of capital, limited partnership status
– underperforming management or business model (conglomerates)
– take 2-5% share ownership
Event-driven, merger arbitrage
Activist Engagement
– Board change / replacement of CEO
– Payout policy (dividends and share buybacks)
– Restructuring : takeover, demerger & spin-offs (or opposition)
“Structurally obliged to aggressively seek maximum short-term
extraction”
– Must beat the “hurdle rate” to take their 20% on capital gains
– Bounded by a maximum holding period (3 years)
3

4. Time line of a stylised activist engagement
– Private vs public engagement
Source: adapted from Becht, Franks & Grant 2010
4

5. Examples
– UK
• Hermes Focus Fund (Océ), The Children’s Investment
Fund (ABN Amro 2007, Deutsche Börse 2005-2009)
– US
• Paulson & Co (Cadbury), Wyser Pratte & Co (Lagardère)
– France
• Colony Capital Europe (Carrefour, Accor), Eurazeo
(Accor),
– Sweden
• Cevian Capital (Volvo 2007, Old Mutual)
5

6. Case studies
Accor
– Colony Capital Europe & Eurazeo build up 30%
stake in 2009
• Spin-off of real estate assets in the hotel branch
• Demerging of hotel and voucher activities
• CEO forced out, board change
– Opposition by the EWC and French state-owned
minority shareholder
– February 2010: Standard & Poors downgrades
Carrefour from BBB to BBB-
Source: IUF's Private Equity Buyout Watch
6

7. Case studies
Cadbury
– Takeover bid by Kraft December 2009
– Hedge funds ownership rises from 5% to 30% in 1 month
– January 2010: Board accepts takeover offer
– Roger Carr, Cadbury’s outgoing chairman:
“It may be unreasonable that a few individuals with weeks
of share ownership can determine the lifetime destiny of
many,”
– Adam Lent, TUC :
“it’s a deal which goes through because it is largely
supported by short-term investors after a quick buck than
those with a long-term interest in the company.”
Source: ft.com & http://www.touchstoneblog.org.uk/
7

8. Activist hedge funds
Workers’ capital
Pension fund investment in private funds
Accountability across the investment chain
8

9. Stewardship of
workers’ capital
Activism for
– Board accountability
– ESG reporting
– HR & labour rights
9
Source: TUAC

10. Stewardship of
workers’ capital
Pension governance & funding rules
– Board representation
– risk based supervision, quantitative restrictions
– Pressure on liabilities arising from risk sharing (DB, DC, Hybrid)
– Assets with ownership responsibilities vs fixed income (bonds)
Asset management accountability
– Governance of asset managers, conflicts of interest
– Effective exercise of proxy voting rights
Enabling regulatory framework
– Fiduciary duties of trustees
– Access to the AGM agenda
– Acting in concert – strange bedfellows
– Trade union infrastructure: education, expertise, leadership
Source: TUAC 10

11. The investment chain
Perimeter Perimeter
of the company AGM of the pension fund
(“workers’ as employees”) (“workers’ as investors”)
Asset
Board
management
Board of
Management
trustees
Works council Workers
Source: TUAC 11

12. The investment chain
- international guidance
Perimeter Perimeter
of the company AGM of the pension fund
Asset
Board
management
Board of
Management
trustees
Works council Workers
12

13. The investment chain
- national laws and
regulations
Corporate law Securities law
AGM
Financial regulation
Asset
Board
management
Pension law
Board of
Management
trustees
Works council Workers
Labour law
13

14. Activist hedge funds
Workers’ capital
Pension fund investment in private funds
Accountability across the investment chain
14

15. No regulation, no reliable data
100%
90%
80%
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50%
40%
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20%
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Alternatives (land & buildings, unallocated insurance contracts, private investment funds,
other)
AUM > 10% GDP
Mutual funds (CIS)
Shares
Cash and Deposits, Bills and bonds issued by public and private sector, Loans
15
Source: OECD Pension Markets in Focus 2007 www.oecd.org/daf/pensions/pensionmarkets & www.oecd.org/dataoecd/47/0/39510746.xls

16. From quantitative restrictions to
prudent person standard
16
Source: Source: OECD Survey of Investment Regulations of pension funds, July 2008, www.oecd.org/dataoecd/12/46/40804056.pdf

17. In need of harmonisation?
Country Quantitative restrictions (% of AUM) Average Exposure (% of
AUM)
Austria 30% max in unlisted securities (incl. HF)
Canada None* 1% (federally regulated plans)
Czech Republic 5% max Estimated up to 1%
Denmark Solvency requirements
Finland Authorised since 1st January 2007 3.10%
Greece 5% max 0%
Ireland 10% max in unlisted securities (incl. HF) Thought to be extremely low
Italy 20% max in CIS (incl. HF); max 1x leverage; short Negligible
selling, lending & borrowing prohibited.
Netherlands Solvency requirements Approximately 2-3%
Poland 10% max in CIS (incl. HF) 0%
Portugal 5% max (to be raised to 10%) 3%
Slovakia Prohibited 0%
Spain 5% max; indirect restriction via caps on fees
Source: OECD 17

18. No regulation, no data
Pension funds’ share of hedge funds’ funding
– 25% - 40% ?
– more if funds-of-funds are included
Hedge funds’ share of pension funds’ portfolio
– Netherlands 3.4%, UK 1.5%, Swiss 3.3%,
Australia 5%, … (exposure)
Who invest in alternative assets?
– Large (sector wide) pension funds
– DB schemes and hybrid DC schemes
Source: OECD 2010 18

19. Implications for PF risk
management
Most challenging aspects
– Selecting, monitoring managers, due diligence procedures
– Fees
– Barriers to entry
The fees
– 2% on annual commitments + 20% on capital gains
– Hurdle rate
Risk management
– Exposure = un-funded commitments + remaining value
– Governance of limited partnerships
Source: OECD & JP Morgan 19

20. Investment strategies in
private equity & hedge funds
Single-Fund investment (2+20%), Fund-of-funds
(1+10% + 2+20%)
Strategic partnerships
– AP1 & Cevian, AP4 & EQT, OregonPERS & KKR, CalPERS &
Carlyle
In-house / arms length private investment firms
– ABP & PGGM owned Alpinvest, Australian Supers’ Industry
Funds Management
– Calpers’ Focus list, BT’s Hermes Focus Funds
Mixed strategy
– Ontario Teachers’: Teachers Private Capital & KKR
20

21. Activist hedge funds
Workers’ capital
Pension fund investment in private funds
Accountability across the investment
chain
– Pension fund risk management
– Governance of private pools of capital
– Shareholder transparency
21

22. Pension fund risk
management
International guidance
– IOPS Good Practices in the Risk
Management of Alternative
Investments by Pension Funds
(2008)
– IOSCO high level principles on the
regulation of hedge funds (2009)
– OECD Guidelines on Pension Fund
Asset Management (rev 2009)
22

23. Risk managing a hedge fund,
an oxymoron?
OECD Survey of pension supervisory authorities
(forthcoming)
“Key Concerns” regarding alternative investments
– Valuation accuracy, liquidity management, price volatility
– Level of understanding and skills
– Inadequate risk management systems
– Non-compliance with quant’ limits or overall risk profile
– Lack of information provided to plan members
AIFM
– Risk management (#11), liquidity (#12), CDOs (#13),
valuation (#16)
– Delegation (#18), disclosure to investors (#20)
23

24. Governance of
private pools of capital
British House of Commons, hearings on private equity
(2007)
– Paul Myners: “Investors can be quite lethargic… [we]
should ask why they invest in private equity with its
association with aggressive capital structures, high
incentives for management and a minimalist approach to
governance … while adopting an entirely different approach
when investing in public equity.”
Limited liability partnerships
– virtually all control in the hands of the general partners
– Un-regulated, no standardisation
24
Source: Private equity, Treasury Committee, House of Commons, 24 July 2007
www.publications.parliament.uk/pa/cm200607/cmselect/cmtreasy/567/567.pdf

25. Governance of
private pools of capital
SRI AGM Engage-
screening voting ment
External management
√ √/X X
Internal management
√ √ √
Bond & fixed income
√ X √/X
Listed equity
√ √ √
Private capital
√ ? ?
Weak AM accountability
√ X X
Weak TU infrastructure
√ √/X X
25

26. Shareholder transparency
Corporate governance: OECD lessons of the crisis
Ineffective monitoring by shareholders
– Both widely held and concentrated structures
– Shareholders’ short termism & excessive risk taking policies
Way forward
– Conflicts of interest of proxy advisors
– Facilitate access to voting
– Institutional investors should not be discouraged from
acting together
– Private equity & activist hedge funds should not be
hampered as a side-effect of regulatory reforms
26
Source:http://www.oecd.org/dataoecd/3/10/43056196.pdf

27. Shareholder transparency
Review of Transparency Directive 2004
– Lowering the threshold to 3%
– Derivatives contract for difference, Share
lending, Empty voting, Beneficial ownership
– Disclosures on intentions & financing
arrangements
– Disclosures of voting policy & ESG criteria
AIFM
– Reporting for significant interest or a controlling
influence in companies (#26-29)
– Delegation (#18), disclosure to investors (#20)
27

28. The investment chain
- EU Directives
Shareholders’ right
AGM
Transparency
Asset UCITS
Board
management
Takeover
(AIFM)
4th company law
Board of
Management IORPs
trustees
Info. & Consult. Acquired Rights
Works council Workers
EWC
28