As part of a new search process, the retirement system will eschew the conventional route of filling its absolute return allocation, and will instead pursue a more risk-orientated asset allocation policy, as it looks to diversify existing strategy buckets.

“Our absolute return ‘bucket’ is currently 0%, but we have a range of 5-7% we can invest in hedge funds. However, our activity in the hedge fund space [has been and] will most likely be under the real assets and credit opportunities ‘buckets’,” Ryan Parham, chief investment officer, told HFMWeek.

Arizona PSPRS intends to use hedge funds to provide some diversification within credit opportunities and commodities (within the real assets allocation). “Some of these assets are housed under hedge fund structures,” added Parham. PSPRS has already made a number of allocations in this space and recently allocated $40m to the Waterstone Market Neutral Fund.

Meanwhile, the retirement system will further increase its exposure to hedge funds and absolute return products by turning to global tactical asset allocation (GTAA) strategies as well as portable alpha strategies, despite the latter having recently fallen out of favour with many pension funds.

“We are also looking to add ‘alpha engines’ to the portfolio in the form of a portable alpha strand, which will mainly use funds of funds in the long-only and hedge fund space,” said Parham. “We are aware that portable alpha has been shunned in the media, with many in the industry stating it is ineffective, however we have looked at it over the longer term and believe it is a good way to achieve risk-adjusted returns.”

Currently, most of PSPRS’s equities portfolio is indexed, but in the near future the fund will look to add alpha-generating returns within the equity space, and again, will consider hedge funds as part of this search. “We will do this partially to gain exposure to portable alpha,” added Parham.

The PSPRS board voted to include hedge funds within its portfolio for the first time in early 2009, and a new asset allocation strategy ensued, formulated by New England Pension Consulting (NEPC).

However, PSPRS held off on a search for managers due to the volatile markets. “We are interested but the markets are in turmoil and we are waiting for the dust to settle before starting any active searches. We will wait and see who the survivors are and what strategies will be successful,” Parham told HFMWeek at the time.

He added that PSPRS would not invest in so-called ‘black box’ hedge funds and will only allocate to funds that offer transparency.

In June 2009, PSPRS hired Albourne Partners as a specialty consultant for the absolute return and hedge fund space. However, NEPC was retained as a specialist consultant for credit opportunities investments, and in May, PSPRS awarded $40m to credit specialist, Oak Hill Advisors, for its OHA Strategic Credit Fund, which targets opportunities in stressed and distressed loans, bonds and other investments. The fund closed in September last year with $1.13bn.

PSPRS also awarded $40m to the Centerbridge Special Credit Partners Fund and $30m to the JPMorgan Asian Infrastructure and Related Resources Opportunity Fund US last year.