Customization has proved to catapult hedge fund of funds into the institutional limelight of late for many small pension and endowment plan sponsors. However, asset size and back office capabilities are still major determinants on whether the inherit fees are worth the worries of commitment to the alternatives vehicle.

Callan Associates, a San Francisco-based investment consultant, said that it was supportive of the move, despite the higher fees.

“…Institutional investors are asking right now whether or not the additional layer of hedge fund fees is worth the sophistication and better customized expertise, and we here at Callan believe so,” Sherwood Yuen, a VP and consultant within the 39-year-old independent firm, said.

Previously, at an April meeting, the Town of Fairfield, Conn. Joint Retirement Investment Board decided it “should look into [hedge fund of funds’] options” for its Police and Fire Retirement Funds and Employees Retirement System. Callan Associates serves as the more than $120 million portfolio’s investment consultant.

At the time, Thomas Shingler, a VP and consultant, said the firm recommended “a fund of funds approach for investors of Fairfield’s size and resources due to the oversight and diversification they provide.”

In a conversation late last month, Yuen explained to IMMP that the firm prescribes “to providing a customized solution/strategy for our clients overall investment portfolios.”

“So there is not one specific mix of sub-strategies that we currently advocate,” Yuen listed. “And…given the current economic conditions, certainly there are some obvious strategies that may be more beneficial or optimal when compared to others…but we do not come in with a prescribed plan.”

To add, Nick De Monico, CEO of Wilton, Conn.-based Commonfund’s Hedge Fund Strategies Group, a division that manages $2.3 billion in hedge funds for nonprofit institutions, pension funds and other leading institutional investors, said the firm also follows a similar motto for its endowment clients.

When asked about the transgressions of the academic nonprofit industry, De Monico said last week that it has “…evolved over time, but I think one thing that has been consistent is that fund of funds have been an attractive way to invest in hedge funds for smaller investors.”

“The reason for that is that smaller investors might not have the staff to be able to do all the initial due diligence that you have to do before you hire a manager, and all the stuff you do in terms of operational due diligence, [and] background checks” De Monico disclosed in a phone conversation. “…They also might not have the staff to be able to do all the risk management and the monitoring you do after you invest…and that’s a very rigorous process as well; it takes a staff of highly trained people to call these managers on a regular basis to determine what was in their portfolios and then to get their positions."

Through Commonfund’s association with the National Association of College and University Business Officers (NACUBO), its 2011 NACUBO-Commonfund Study of Endowments highlighted in its January report that the alternatives asset class’s more than 53% allocation contributed an aggregated 9.5% return among the 823 U.S. college and university endowments and foundations included in the report.

Marketable alternatives, included in the overall allocation, includes “hedge funds, absolute return, market neutral, long/short, 130/30, event-driven strategies and derivatives.” Within the study, which consists of collective endowment assets under management of over $400 billion, NACUBO-Commonfund listed that plans range between under $25 million to over $1 billion.

However, if plans like the Ohio Public Employees’ Retirement System (OPERS) and the Massachusetts Pension Reserve Investment Management (PRIM) are willing and able to pursue direct hedge funds, minus the fees, the sky’s the limit for commitment potential.

Recently, in May, the Columbus, Ohio-based plan disclosed it had committed total funding of nearly $1.8 billion to hedge funds, with a $120 million investment being made to COMAC Capital, a London-based investment manager of a macro/discretionary product.

It was noted that the plan’s “staff expects to fund additional hedge funds during the second and third quarters.” Presently, the more than $70 billion OPERS had its commitment to hedge funds spread out among two fund of hedge funds and 11 individual firms, the plan summary said May 16.

In February, OPERS CIO John Lane disclosed in its 2012 Investment Plan that the plan will supplant its 3% increase to the hedge funds class by the “hiring of direct hedge funds identified with the assistance of OPERS’s due diligence consultant.”

In his comments to IMMP, Lane confessed that “OPERS initially began its hedge fund program utilizing fund of funds.” However, “OPERS staff has developed the expertise to build and monitor these hedge fund portfolios internally,” he added.

“Some of the benefits of investing direct are cost savings, the fact that we're better able to monitor the risk of the hedge fund portfolio, we have direct contact with the hedge funds portfolio managers, and investment research is shared directly with the plan,” the lead investment officer for OPERS explained.  

Additionally, the manager for the Commonwealth’s more than $50 billion PRIT Core Fund has also been in the news for its hedge fund modifications. In April, the PRIM Board decided to terminate hedge fund of funds Arden Asset Management, Grosvenor Capital Management, K2 Advisors and Rock Creek Group in order to get the ball rolling with its “Direct Hedge Fund program.”

Arden Asset Management was slated Thursday to take over the hedge fund of funds transitional manager mandate to assist with the changes; the Board was to vote on the item at its regularly scheduled meeting.

The Boston-based retirement fund agency said its plans will hold an 8.5%, or $4.2 billion commitment, to direct hedge funds, and allow for 1.5% or $750 million for hedge fund of funds. Collectively, direct hedge funds previously held about 3% of the portfolio, while hedge fund of funds maintained 7%.

IMMP’s attempts to gain a follow up from Michael Trotksy, PRIM’s executive director, regarding the merits of the move were not successful.

Performance pacing

Of late, K2 Advisors, a Stamford, Conn.-based firm, has found itself in a negative light at some of its plan sponsor clients. For instance, on May 24, the $483 million Fort Lauderdale Police & Fire Retirement System Board decided to raze its weighting to long/short strategies.

Fred Nesbitt, the system’s director of media relations, told IMMP that Board members for the retirement system elected yesterday to cut its weighting to long/short strategies. The Stamford, Conn.-based hedge fund of funds firm advised approximately $25 million of the pension funds assets, Nesbitt said, while noting K2 Advisors first linked up with the plan in 2008.

He explained at the time that the Board “voted yesterday to get out of long/short hedge funds as an asset class.” CapTrust Advisors, its investment consultant, advocated the move after it was disclosed the hedge fund strategy has been underperforming of late, which implicated K2 Advisors’ mandate.

In comments offered by David Saunders, K2 Advisors’ co-founder and managing partner, it was highlighted that the current movement is “a fad not a trend.”

“I think it’s a short-term phenomenon as clients are trying to understand what is the best root or path to take for their investments and for their hedge fund exposure,” Saunders said in a phone conversation with IMMP.

Presently the firm, which employs about 115 people, partners with clients in three ways: it offers a commingled product, customized portfolios, and strategic advisory services for larger asset plans looking to find a partner with whom its internal staff can work to implement their ideal exposure to the asset class.

With market factors and sector volatility afoot, Callan Associates’ Yuen confessed that when looking at fund of funds, most are invested in some sort of long/short equity. Other strategies include absolute return and multi-strategy, which is an amalgamation of beta and absolute return focuses.

“Generally, over the past three years, the overall global markets have been dominated by macro economic themes, and much less than general underlying fundamentals of each asset class, and that has certainly impacted the hedge fund space much like the traditional asset classes,” Yuen listed, while noting that “performance has been difficult for hedge funds, because specific hedge fund strategies do rely on specific market fundamentals for them to work.”

However, over the long term, according to a May study presented by the Alternatives Investment Management Association and KPMG, it was that hedge funds posted a 9.07% return over the period between 1994 and 2011. The 17-year’s worth of data, prepared for a peek into the Canadian market, listed that global bonds hit a 6.25% return; global stocks, 7.18%; and commodities posted a 7.27%.

The correlation among hedge fund performance to that of the traditional scene could be forgotten, however.

“I think once the market returns to some sort of normality, given the current economic climate that we are in…hedge funds will perform much like they did historically,” Yuen said in May. “I think we are in a relatively unique and somewhat difficult time for hedge funds in general.”

Specifically, according to a look at IMMP’s Leads Database, from period between September 2011 and May 31, hedge fund of funds strategies have garnered about over $1 billion in potential, actual and closed search activity. Also, hedge funds have included $4.3 billion over the same period, the database stated, indicating a high take up with the strategies in recent period. 

Hedge funds’ future

According to Callan Associates, the underlying trend for demand has shifted the market into a body of familiar faces and names, where “the large fund of funds are growing larger, and the small fund of funds are growing smaller or basically exiting the market,” Yuen listed.

Within the nonprofit financial landscape, De Monico highlighted that separate accounts have proved to consume about half of its assets under management presently.

“I think we’re seeing more and more of our larger clients moving towards this separate account mandate structure, where they don’t want to be a part of a commingled funds with 200 investors, they want their own fund,” De Monico commented. “…They want it to be more collaborative but they want to have something say about what kind of managers are in the portfolio, what kind of strategies they are looking at, so its become much more of a collaborative process, and much more of a bespoke, customized process for the larger clients.”

“Larger clients will want to have more discretion in their own funds, and that’s fine,” De Monico added. 

Saunders added that “this is an asset management trend, this is not a hedge fund trend, for plan sponsors, to want to have less manager count in their investments and more strategic relationships with investment managers.”

“They want to extract more of the skills and resources of the firms they invest with,” Saunders disclosed. “I think that trend is in only in the very beginning stages.”

While continued growth is expected, global and U.S. plan sponsors are beginning to use hedge funds for different purposes among their asset classes. In certain instances, some have popped up as a low-risk bond replacement, or a vehicle that looks to diversify by adjusting correlations to stocks in different geographies, Saunders said.

“…The way they are being applied to institutional portfolios is differing in country by country, and in some cases by client type by client type,” he explained.


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