28/07/2010 Author: Kapila Gohel

Big mandate on campus

Along with most investors, US endowments and foundations retreated from the hedge fund space when crisis hit in 2008, but they have been quick to return and, with many planning allocation increases this year, are driving the institutional return to the alternatives sector

Lighting the way for institutional investors, endowments and foundations found their way into alternatives and hedge funds a long time ago. As long-term, sophisticated investors, they found hedge funds to their liking and created sizable allocations to them.

By June 2008, endowments with assets of more than $1bn were investing 22.6% in hedge funds, according to the annual survey produced by the National Association of College and University Business Officers (Nacubo).
But despite being trailblazers into the alternative investment space, like everyone else, university funds backed away from hedge funds following the market fall-out of 2008.

If the withdrawal was sudden – marking a two-year hiatus from hedge funds – US endowment funds are now demonstrating a similar turn of speed as they move back into the space. “What’s interesting is that US endowments, foundations and pension funds were the quickest to react to the proven benefits of hedge funds after the events of 2008,” says Paul Graham, global head of alternatives at UK hedge fund Gartmore.

The endowment funds agree, and point out that they are back on the road to meeting planned allocations. “We stalled our programme for a while, but not for long,” says Jerry Ganz, chief financial officer at the $400m Florida University Foundations. “What we had invested helped provide some downside protection and we are now building up to our [20%] target allocation.”

Endowments and foundations were quick to realise the long-term benefits of alternative investments. The University of California, the 12th largest endowment investor in hedge funds, as reported in the 2008 Nacubo Endowment Study, experienced 10% declines in the Q3 2008 in both its $5bn General Endowment Pool (GEP) and its $31bn retirement fund, which were “wholly due to the absolute return portfolio”, according to its investment committee minutes from early last year.

Despite this drop, the University increased its absolute allocations in both portfolios not once, but twice in 2009, as Linda Choi, marketing director overseeing the university’s hedge fund programme, advised the committee not to change its strategy. She argued the portfolio had outperformed most equity market indices, on a trailing five-year and three-year basis, and at much lower risk.

“There is definitely some renewed interest in hedge funds,” says John Griswold, executive director at the Commonfund Institute, the education and research arm of the investment firm managing more than $25bn for institutions. “But it is a lot more cautious than it used to be. They [institutions] are clearly interested in the diversifying and risk/return benefits of hedge funds, but there is still some anxiety in the space.”

As a result, most institutions are looking for low-volatility strategies, particularly as interest rates are at a historical low. “There may be some people out there looking for returns but endowments and foundations, as long-term investors, are not; they are looking for long-term partners,” Griswold added.

Specialist hedge fund consultants are also having a say in what US university funds are looking for, says Gartmore’s Graham. Traditionally, the lion’s share of a US investor’s investment portfolio went to US managers, including those that invest globally.

“Now the trend has shifted. If US investors want diversification, they are now looking at ‘specialists’ such as European managers for European equity, and much of this has been driven by their specialist hedge fund consultants,” he says.

That is also true of Asia as endowments and foundations seek dedicated local managers for specific strategies rather than say a New York-based Asian hedge fund. Although, as HFMWeek’s own research pointed out last week, investors in the region are also looking for opportunities further afield.  

Returning to historical allocation targets indicates returning confidence. Even more interestingly, Griswold states, is that, for the first time in long time, US endowments and foundations are re-assessing their asset allocations and are likely to pledge more to the hedgefund space.  

While many university funds, mainly the larger endowments, break down their hedge funds using a risk-based approach, many still include them in their alternatives allocations. Griswold believes that a mass re-assessing of investment priorities may change this, as institutions that have traditionally used the asset allocation approach move to a more risk-based model – a shift that means money managers are likely to see a growing number of searches for investments spanning their portfolios, such as equities, fixed income, credit and so on, in a hedge fund package.

It’s a development that could spur further hedge fund investment. In the midst of their re-engagement with hedge funds, US endowment funds are providing a beacon for other investors. And if increasing numbers alter their hedge fund approach, other types of investors could well follow.