30/03/2011 Author: Elana Margulies

The path to diversity

The latest HFMWeek US Subscriber Breakfast Briefing discussed allocation plans at US public pension funds, with the panel shedding light on the growing importance of hedge funds for institutions looking for diversified portfolios, but also the operational demands required to secure these cautious investors Public pension funds have long maintained a schizophrenic relationship with managers. Often critical of standards at funds, trustees are also increasingly embracing the sector as they hunt for greater diversification and returns. The more positive side of this relationship was emphasised at HFMWeek’s US Subscriber Breakfast Briefing last week, where a panel of experts, representing Hewitt EnnisKnupp, City of Richmond Retirement System and SkyBridge Direct, agreed that the use of hedge funds and funds of hedge funds (FoHF) is of increasing interest to this particular group of allocators. Louis Kahl, co-head of hedge fund research at Hewitt EnnisKnupp, has witnessed this growth first hand. He explained, to a packed auditorium, that since Q4 2010, public pensions had been busily boosting their existing hedge fund allocations. Recent searches, according to Kahl, had  focused on macro, event and credit-oriented strategies, while smaller investors were re-engaging with FoHFs. The relationship still isn’t a totally harmonious one. Institutional investors continue to question fees and levels of transparency at hedge funds, with some still wary of an industry that is capable of attracting bad publicity, particularly the recent pay-to-play scandal. Yet, all speakers agreed that the sector was proving hard to resist, particularly with improved operational standards on show at many funds. A successful battle for hearts and minds has been demonstrated by the arrival of neophyte investors, including smaller pension funds. Panellists agreed that a growing interest among this stripe of investor has been particularly beneficial for FoHFs, a sector that has endured several years of suspicion and rancour. Don Steinbrugge, chief executive of third-party marketing firm Agecroft Partners and a member of the investment committee of the City of Richmond Retirement System, believes that smaller pension plans still favour FoHFs over direct investment, as under-resourced investors look for less complicated ways to diversify and gain alpha. “I don’t believe they will move away from FoHFs,” he said, “because the majority of small investors don’t have the time or resources to look at individual managers.” The City of Richmond Retirement System has an 8% allocation to hedge funds, primarily invested in three FoHFs and two single manager strategies that are hedge fund and private equity hybrids. Following a recent investment committee meeting there are no plans for the pension to boost its hedge fund exposure. While Richmond’s appetite is sated, for the time being, others are acting fast, with a growing number of investors keen to fit specific hedge fund strategies into their system’s more opportunistic bucket – as they move away from narrow definitions of alternative investment. Kahl described the process to the audience. “In regards to credit, we are having conversations with clients about fitting long/short credit into their fixed-income allocation as opposed to only in their hedge fund bucket,” he said. “Regarding long/short and where that fits, again it is primarily targeted for the hedge fund bucket, but we are encouraging the idea of global unconstrained equity and are having conversations with clients as to how that may fit more broadly within their larger equity allocation, as opposed to just traditional long-only equity.” Investment advisors began recommending ‘opportunistic’ investment portfolio allocations in response to concerns over the effectiveness of traditional asset allocation strategies. Responding to this challenge, the New York State Common Retirement Fund (NYSCRF) has put together a cross-asset class committee to test this approach, and has deployed capital to a distressed mortgage hedge fund. “The committee at New York State appreciated that hedge funds are the best strategy for opportunistic investing,” said Robert Mazurek, former portfolio manager from the pension. “In contrast to equilibrium asset allocation models, hedge funds are concerned with mispricings and, as a consequence, are opportunistic. I expect that the role of hedge funds in tactical allocations like this will continue to grow. Hedge funds serve the need that ‘opportunistic’ plans are looking for.” A development that will benefit the industry over the course of 2011