Investment Director Paul Bishop on Railpen’s changing approach to pooled funds, and why it stepped back from hedge funds long before CalPERS.

Paul Bishop, investment director, Railpen (Art by Chris Buzelli ) The investment manager responsible for the pension assets of the UK’s railways is on the hunt for more staff as it transforms its process and structure.

As Investment Director Paul Bishop tells CIO. the appointment of Richard Williams as Railpen’s first chief investment risk officer  in April, alongside the creation of a four-man chief investment office, was just part of the group’s “transformation project”. This process has so far has taken 18 months and seen a dramatic change not only in staffing but also governance, investment strategy, and resources for the £20 billion scheme.

“The transformation project… addresses all aspects of our investment process—from governance to how we access investments,” Bishop says.

“The governance process is about making investment decisions more efficiently. We have developed the team, what we stand for, what we believe in.”

“Whereas before the pensions would have had holdings in our equity pool, hedge fund pool, and so on, now they’ll have a holding in the growth pool to get exposure to risk assets.”—Paul Bishop, investment director, Railpen One example is Railpen’s allocation to hedge funds, which has fallen from 5.8% in a dedicated “silo” at the end of 2009 to 0.4% at the end of 2013. Bishop says the pension’s decision to cut this exposure was for “similar” reasons to the California Public Employees’ Retirement System (CalPERS). CalPERS earlier this month outlined plans to wind up its $4 billion hedge fund program  due to a lack of scale, high fees, and complexity.

But rather than Railpen abandoning hedge funds altogether, Bishop says hedge funds “can be a means to an end” in some cases.

“We don’t see hedge funds as an asset class,” he explains. “When you aggregate exposures you tend to get a poor trade-off between expected return and costs.

“They are expensive but we may be willing to pay to access specific opportunities, where the net value add is attractive, for example structured credit over the last couple of years. Hedge funds are all sold as alpha but you need to have extremely high conviction to justify the fees especially in a low growth, low interest rate environment.”

On the staffing front, Bishop says Railpen will be building its internal capabilities to bring “research, analysis, and implementation” in house where appropriate. Railpen’s Richard Moon, investment manager for private equity, is “working hard to build a team” with the ability to be a capital provider in unlisted markets, Bishop added.

Elsewhere, Railpen is also “restructuring what we offer to clients”, he adds. The eventual aim is for a “one portfolio approach” to improve the investment team’s ability to generate returns.

The move towards “one portfolio” began in 2010. At the start of that year, Railpen’s largest allocations were to global equity, private equity, and global bond portfolios. Each asset class had its own “silo”, and each of the 200 individual pension clients of Railpen would allocate to the silos.

During 2010, Railpen launched the “growth” pool, a multi-asset portfolio designed to be the main risk-seeking allocation on offer to the railway company pensions. By the end of the year it had £6 billion of Railpen’s assets, while the global equity pool had shrunk by £2.5 billion, and the global bond pool had been emptied completely.

By the end of 2013, growth had £10.9 billion—54% of Railpen’s assets—and the group had reduced dramatically its reliance on separate pools for commodities, index-linked bonds, property, and hedge funds.

Bishop says the growth pool “allows us to make relative value decisions and choose the best way to execute an idea”.

“With silo strategies you can’t do that as effectively, [so] we have developed an innovative team structure to encourage our ‘one portfolio’ approach,” he adds.

“Whereas before the pensions would have had holdings in our equity pool, hedge fund pool, and so on, now they’ll have a holding in the growth pool to get exposure to risk assets,” Bishop explains. “It allows us to make cleaner, better investment decisions. Clients’ risk is managed by the allocation between growth and defensive assets.”

Bishop says the eventual aim is to reduce Railpen’s reliance on individual asset class pools to focus on growth—with an illiquid asset pool for infrastructure, private equity, and other related asset classes—for the majority of assets.

Paul Bishop was speaking to CIO  as part of the 2014 Power 100 list, which will be published next month. He has previously ranked #70 in 2013  and #74 in 2012 .