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The Rocaton Way

In the four years since they walked out on their former employer, the partners at Rocaton Investment Advisors have built a pension consulting firm around big, savvy clients that share their appetite for hedge funds.

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Sheila Berube liked to claim that, unlike many of her peers, she didn’t need an investment consultant to help her manage pension assets. As director of cash and investments in the treasurer’s office at Allina Health System, a not-for-profit hospital and clinic network in Minneapolis, she oversaw $600 million in endowment funds and a $200 million defined benefit fund before taking the pension reins as finance manager at conglomerate 3M Co. in February 2002.

Soon after she landed at 3M, maker of Scotch tape and Post-It notes, Berube began to make plans to invest some of its now $9.1 billion defined benefit plan in hedge funds. Berube had narrowed her choices to six funds of hedge funds when she received word from the plan’s trustees: No consultant, no hedge funds.

“The investment committee was very nervous because we had some negative experiences in the ’90s and felt that they wouldn’t be comfortable investing in hedge funds unless we had an extra layer of fiduciary oversight,” says Berube, referring to 3M’s ill-fated investment in David Askin’s hedge fund Granite Corp., which collapsed during the bond market rout of 1994.

So Berube turned her attention to finding a consultant, and after vetting all the choices, she came up with a clear winner to help her construct a complicated portable-alpha strategy involving multiple hedge funds, leverage and derivatives: Rocaton Investment Advisors, a small investment consulting firm located in Norwalk, Connecticut, that had been in existence for just seven months and had 15 clients.

“After realizing that a lot of the big consultants were either just starting this up or weren’t really focused on hedge funds, Rocaton really stood out as a group that had experience,” Berube explains. “They understood hedge funds as a separate product, as opposed to lumping them with other alternatives.”

Berube’s willingness to place her trust in a firm with little history says a lot about the reputation for innovation and risk-taking that Rocaton’s 16 founding partners had built at Darien, Connecticut-based consulting firm Barra RogersCasey. Several of the partners, including Rocaton CEO Robin Pellish, spent more than a decade at RogersCasey.

The group’s appetite for risk was evidenced by their decision to walk in the spring of 2002 when parent Barra unexpectedly sold RogersCasey to a rival firm, Chicago-based Capital Resource Advisors. They opened Rocaton just four days later. Although it might have seemed unwieldy to launch a new firm with so many partners, establishing a deep bench of talent was essential for the team to be able to compete against its former employer, not to mention against much bigger players, like Boston-based Cambridge Associates, which has more than 750 clients.

“You start with that kind of group because you want to work with reasonably large, complex organizations and it’s hard to find good people at the senior level,” explains the 49-year-old Pellish. “You want to say with conviction, ‘Yes, we’re new, but we have all this senior expertise.’”

In the four years since its inception, Rocaton has set out to remake the pension consulting model by seeking engagements with big, sophisticated clients like 3M and the $30 billion Pennsylvania State Employees’ Retirement System. The 16 partners at Rocaton — which now has 37 employees, 52 clients and advises on some $250 billion in assets — are choosy about whom they open their doors to. They screen potential clients to gauge their intellectual curiosity and appetite for alternative asset classes, especially for hedge funds, and have been known to turn away business.

“If you want to hire us, you have to be interested in hearing how we explore new ideas,” says co-founder David Katz, 39, head of business management and client service. “Alternatives may not be right for all our clients, but you better believe we talk to them about whether or not alternatives makes sense for them.”

“We believe there should be less and less emphasis on what other people are doing,” adds Joseph Nankof, 40, who headed up investment consulting at RogersCasey before co-founding Rocaton.

With nearly a third of his plan’s pension assets invested in hedge funds, PennSERS chief investment officer Peter Gilbert would have it no other way (see box, page 56). “We like Rocaton because they’re willing to consider new investment strategies and ways to approach the universe as it changes,” says Gilbert, who was one of the first RogersCasey clients to move his business to Rocaton. “That flexibility and insight is valuable.”

At the start of this year, the Rocaton partners ranked No. 13 among the biggest pension consulting firms in reported assets under advisement, one spot behind their old firm, now called CRA RogersCasey, according to the 2006 Thomson Nelson Annual Report of Pension Fund Consultants. Rocaton ranked No. 4 among firms in terms of average assets of its pension-plan sponsor clients with at least $100 million, right behind uberconsultants Russell Investment Group of Tacoma, Washington. Russell’s 349 plan sponsor clients had, on average, $15.9 billion in pension assets; Rocaton’s nine $100 million–plus clients had an average of $11.2 billion. The 260 such clients at Cambridge Associates, No. 19 in the ranking, had, on average, $3 billion in assets. (The top-ranked firm, Chicago-based Richards & Tierney, had 20 clients in the $100 million–plus range with an average of $31.3 billion each).

Rocaton’s decision to focus on hedge funds appears prescient in light of the Thomson Nelson report’s conclusion that plan sponsor use of “true pension consultancies” has been in decline since 2002 as many have turned to investment management firms for consulting advice. At the same time, the percentage of U.S. pension plans investing in hedge funds has continued to climb. It’s now at 26.6 percent for public plans and 18.5 percent for corporate ones, according to the 2005–06 Russell Investment Group Survey on Alternative Investing. By contrast, about two thirds of endowments are hedge fund investors.

For pension consultants, the hedge fund space has become the best game in town, in part because of the dire state of the pension industry. The U.S. Department of Labor has estimated that there is a $450 billion gap in the funding status of defined benefit plans. To shore up these funds, companies like IBM Corp. and Alcoa have closed their pension plans to new employees; others, like US Airways, have terminated them entirely.

The U.S. Congress passed a compromise pension reform bill in August to try to remedy this problem. Although provisions in the bill make it likely that pension sponsors will more closely match assets to liabilities in the future, the need for sources of steady positive returns is more acute than ever. Pension officials will continue to turn to hedge funds as a way to generate alpha and bolster returns, creating opportunities for firms like Rocaton.

The numbers at Rocaton speak volumes: 60 percent of its clients, primarily corporate pensions, are invested in hedge funds or some absolute-return strategy. But it’s not just about the hedge funds. Rocaton has moved well past recommending a “starter” portfolio with a 5 percent allocation to funds of hedge funds and is leading clients like the San Diego County Employees Retirement Association into more-esoteric investment strategies — including building separate alpha and beta portfolios — using multistrategy and single-manager funds.

“We do more aggressive investing than the average public pension fund, and Rocaton is partly responsible for that,” says San Diego County chief investment officer David Deutsch. As of July 31 the $7.7 billion fund had $1.5 billion in hedge funds wrapped in what Deutsch calls its alpha engine, which, like most portable-alpha strategies, uses swap contracts to replicate the returns of the U.S. stock market. The alpha, or excess return, generated by its hedge fund managers is then added to the market returns. Advised by Rocaton partner Christopher Cesare, Deutsch has been adding new hedge fund strategies to his alpha engine.

The shift at Rocaton from funds of hedge funds to multistrategy and single-manager funds has been dramatic. Less than three years ago, 70 percent of the firm’s hedge fund–investing clients were in funds of funds (the rest were split between multistrategy and single-manager funds). Today just 35 percent of Rocaton’s clients are in funds of funds; allocations to multistrategy and single-manager funds have climbed to about 45 percent and 20 percent of clients, respectively. In total, Rocaton’s clients have $14 billion invested in hedge funds. (For more on how Rocaton picks hedge funds, see box, page 58.)

Rocaton’s rise has not gone unnoticed by the hedge fund community. “They don’t want to be just another consulting firm,” says David Kabiller, a founding partner at AQR Capital Management in Greenwich, Connecticut, a popular name on the Rocaton list of recommended investment firms, with $9 billion in quantitatively driven hedge fund strategies and $19 billion in long-only equities. “They’ve become expert in alternatives investing as a point of differentiation and added value to their clients.”

Charles Winkler, chief operating officer of Greenwich-based multistrategy firm Amaranth Advisors, agrees. “Rocaton is unique in the consulting world merely by the fact that they truly understand hedge funds,” says Winkler, whose firm has $8 billion in hedge fund assets and is also on the Rocaton buy list. “They were early in being targeted and knowledgeable in the direct hedge fund space.”

To be sure, some market observers question any consultant’s ability to pick single-manager hedge funds. They point to the deep — and richly remunerated — benches of analysts assembled by fund-of-hedge-funds firms as better equipped for this job. The challenge for consultants who source and monitor single-manager funds is to provide the same level of due diligence without charging the 1 percent management fee and 10 percent performance fee common at many funds of funds. A report issued in September 2004 by management consulting firm Casey Quirk & Acito (now Casey, Quirk & Associates) found that because of the arduous due diligence necessary to source, select and monitor hedge funds — and the dearth of consultants that do it — investors were turning to fund-of-funds managers as de facto consultants.

John Casey, founder of Darien, Connecticut–based Casey Quirk and co-founder of RogersCasey, views hedge fund manager research as “a coverage and economics issue.” He fears that consultants, like their own alternative investing clients, may have to spend 90 percent of their time on just 10 percent of their assets. “It’s a demonstrably higher-cost research effort than they had six or seven years ago, and clients are going to have to pay for it,” says Casey, who shifted from investment consulting to management consulting when he sold his first eponymous company to Berkeley, California–based risk management firm Barra.

Timothy Jackson, head of hedge fund research at Rocaton, pooh-poohs Casey’s concerns. He says that Rocaton is not in competition with funds of hedge funds to source top managers. Jackson adds that his firm can be more selective than most funds of hedge funds when it comes to which managers to vet because it doesn’t need to worry about creating capacity. Loyalists like Berube, Gilbert and Deutsch count on Rocaton for its independent, in-depth coverage.

CREDIT FOR ESTABLISHING the first private U.S. corporate pension is generally given to American Express Co., which established its plan in 1875; by 1929 close to 400 large companies had plans, including General Electric Co. and American Telephone & Telegraph Co. The Taft-Hartley Act in 1947 enabled unions and employers to begin cosponsoring pension plans. General Motors Corp. established its pension plan in 1950, and by 1960, 41 percent of private sector employees — 18.7 million workers — were covered by a defined benefit plan. As the number of plans grew, sponsors began to need help sourcing and monitoring asset managers and the pension-consulting industry was born.

Many of today’s leading consulting firms began rather humbly. Bill Mercer started his pension consulting business out of his car in Vancouver, British Columbia, in 1945; his firm, William M. Mercer, was acquired by insurer Marsh & McLennan Cos. in 1959 and expanded to the U.S. George Russell founded Russell Investment Consulting in 1969 after he discovered during a sales call for his late grandfather’s brokerage firm, Frank Russell Co., that retail giant J.C. Penney needed help evaluating money managers.

In the early days pension consultants sorted through a small number of asset managers — mostly big banks and insurance companies. The grim economic environment of the 1970s and the 1974 introduction of ERISA shook the world of pension investing from its slumber. By the end of that decade, boutique money managers began to proliferate in response to a perceived need for more nimble investment capabilities. That created an opportunity for entrepreneurial types like John Casey, who in 1976 co-founded Rogers, Casey & Barksdale with Stephen Rogers and Edgar Barksdale to help pension sponsors navigate a burgeoning menu of rules and regulations.

“We functioned as their staff down the hall,” says Casey, who had previously worked in manager research at several consulting firms, including the Chicago office of San Francisco–based Callan Associates. In 1996, Casey sold his share in what was by then RogersCasey to Barra. He stayed on as a director at Barra and within the new ownership structure started Barra Strategic Consulting Group, a management consulting practice.

In 2000, Barra decided to get out of its noncore businesses to focus solely on analytics. At the same time that Casey was making plans to exit with his team, a lead group of managing directors, including Pellish, Katz, Cesare, Nankof, Anne Buehl and Roger Fenningdorf, presented Barra with a management buyout proposal. As senior managing partner, Pellish was effectively CEO of Barra RogersCasey; the group also included heads of most of the firm’s major functions — client service, investment consulting and global manager research.

The buyout never made it off the table. In March 2002, Barra received a higher outside offer of $14 million for RogersCasey by Capital Resource Advisors, run by former McKinsey & Co. consultant Kevin Greene, who had begun buying up pension consulting businesses three years earlier. When Greene arrived to take over RogersCasey, which had about 90 employees, the managing directors were in effect fired and offered new employment arrangements, says Katz. Taken by surprise by this turn of events, the top management team, led by Pellish, Nankof and Katz, walked out the Thursday before the Passover and Easter holiday weekend.

“We had a weekend to open the [new] firm,” says Pellish. Members of the management buyout group met at Buehl’s house on Rocaton Road in Darien, thus inspiring their new firm’s name. By Sunday night all 16 partners were on board, including junior staffers Jackson and David Morton.

“With one exception, the two people with least tenure in the firm were me and Tim,” says Morton, who admits to having had some pangs of doubt leaving a good paying job at a well-respected firm to become a partner in a new venture that had neither clients nor revenue. “We brought something significant to the table in the one year we’d been at RogersCasey, and Rocaton recognized that.” Morton is co-head of alternative investments with Jackson and spends about three quarters of his time working on hedge funds.

In the first weeks Rocaton partners juggled the demands of building a new business. Meetings with investment managers were held at a local Starbucks until office space could be found. Roles were assumed according to each partner’s interest and expertise. Pellish remained CEO, while Katz signed up to head banking, credit and finance. Research was structured as a partnership-level role, of equal weight to the generalist consultant position and with the same compensation arrangement. Seven of the 16 partners are full-time research analysts. “The way we approach the business makes it viable to have research as a career,” says 40-year-old research head Fenningdorf.

RogersCasey clients had to choose whether to stay put or follow the people with whom they had forged long-standing relationships. As an interim solution, several pension sponsors kept their mandate with RogersCasey while engaging Rocaton. Among the first to follow were Gilbert of PennSERS and Christopher Krauss, director of employee benefits at BASF Corp. in Florham Park, New Jersey.

“We followed them because they were the people that worked with us,” says Krauss of his company’s decision to go with Rocaton. “That just made sense.” By the summer of 2002, 15 clients had moved to Rocaton. The firm opened an office in Darien before moving to their current Norwalk location in May 2003.

The transition was tricky. Greene, who declined to comment on Rocaton for this story, took Pellish, Katz, Nankof and the others to court for violating noncompete clauses. The former RogersCasey employees countered that the noncompetes were invalidated by the changed ownership structure. By June 2003, Rocaton and RogersCasey resolved their dispute. (Neither side would comment on the terms of the settlement.) During that period Casey, who had had a hand in hiring 12 of the 16 Rocaton partners at RogersCasey, offered support that included systems and accounting help from two members of his own consulting team. “In a way it’s like talking about my children,” he says of his fondness for the Rocaton crew.

HEDGE FUNDS ARE AT THE CORE of the Rocaton way. While at Barra RogersCasey, the firm’s partners were early to recognize that hedge funds are an alpha generator, not an asset class, and as such can play an important role in any investor’s portfolio. But the decision to specialize in hedge funds — and to market that expertise — was three parts foresight and one part luck. “When we started Rocaton, hedge funds were just beginning to be considered seriously by the institutional investor community,” explains Katz, who worked in treasury at Goldman, Sachs & Co. in New York before getting into investment consulting in 1997.

Although Rocaton saw hedge funds as a key driver of its future success, the lead research role was up for grabs. “We didn’t have at the outset someone earmarked to spearhead that area, so I raised my hand,” says Jackson, 32. “We saw that hedge funds would be an increasing area of need.” Jackson was deemed a good fit because he had worked for two and a half years as an analyst researching managers at Northern Trust Global Advisors’ long-only and fund-of-hedge-funds business in Stamford, Connecticut.

Rather than try to compete with much bigger rivals like Russell and Cambridge Associates on size, the Rocaton founders envisioned a firm that would provide customized solutions for clients who wanted to work in partnership with — rather than be dictated by — their consultants and to receive a deep level of personal contact. Both Rocaton’s partners and its clients like to talk about the “push-pull” notion of collaboration to explore the newest investment ideas.

“The value there is that both the client and the consultant are able to challenge each other to explore new ideas and new places to go,” says PennSERS CIO Gilbert. “If you look at our program as a whole, I think we look somewhat different from other public plans.” Different indeed. With Rocaton’s help, the $30 billion Pennsylvania fund has invested about $9 billion in hedge funds.

Rocaton’s high-touch service comes at a price. Clients must be willing to pay a premium for the luxury of being handled by a senior partner who services an average of only seven clients. “You can’t do it right if a consultant has 20 clients,” says Pellish. PennSERS, for example, paid $427,000 in fees to Rocaton in 2005; the San Diego County Employees Retirement Association reported paying an annual fee of $443,000 for the fiscal year ended June 2006.

Rocaton’s earliest forays into hedge fund investing met with some initial resistance from managers. Many didn’t want to open their firms to the level of scrutiny that the pension funds and their trustees, represented by Rocaton, would demand before investing in a hedge fund.

“At the first meetings we set up, not everyone took it well,” Katz recalls. “Suddenly, we were knocking on doors of hedge fund managers saying, ‘Can we come in, can we do due diligence?’” Most managers ultimately adapted, adds Katz, realizing that the pension funds that firms like Rocaton can bring have serious — and sticky — money. Getting on Rocaton’s buy list can be something of a bonanza for hedge fund firms like Amaranth, AQR and New York–based Ramius Capital Group.

As Rocaton’s hedge fund expertise has grown, the firm has steered clients away from funds of hedge funds and toward multistrategy and single-manager funds, in large part to avoid paying the extra layer of fees. Berube of 3M has seen that evolution in thinking firsthand. In 2002 when she arrived at 3M, which had sworn off hedge funds after losing its entire $33 million investment in 1994 when Askin’s Granite Corp. filed for bankruptcy, Berube inherited a portable-alpha program powered by enhanced index funds. With the help of Rocaton’s Jackson, she was able to persuade 3M’s pension trustees to introduce a new portable-alpha program, using hedge funds, that was tied to the plan’s large-cap U.S. equity investments. Today 3M has $360 million in the program, divided equally among three fund-of-funds firms: New York–based Blackstone Alternative Asset Management, Rock Creek Group of Washington, and UBS’s Alternative Investment Solutions in Stamford, Connecticut.

In 2005, Berube decided to set up a portable-alpha program for 3M’s fixed-income portfolio. By then Rocaton was recommending multistrategy funds. “Once you look at the fees and you realize that a big chunk of what funds of funds are doing is in multistrategy funds, you figure if you can get a good combination of multistrats, you should be able to put together your own fund of funds,” says Berube, who turned to Rocaton for its “top picks” and for help in figuring out the expected correlation between managers. The fixed-income program now consists of a total of $640 million invested with Amaranth, AQR, Westport, Connecticut–based Bridgewater Associates, Greenwich-based JD Capital Management and Ramius Capital.

If the institutional appetite for hedge funds continues to grow unabated, there may be room at the trough for a variety of consulting models. Generalist consulting firms like Cambridge Associates should continue to prosper. Cambridge, which works with a lot of endowments and foundations, has 26 consultants and analysts on its hedge fund team and oversees 120 hedge fund programs. On the other end of the scale are small independent shops like Rocaton and microboutique Cliffwater in Santa Monica, California. In 2004, Stephen Nesbitt founded Cliffwater, which has a dozen employees, after a 24-year career at Santa Monica–based Wilshire Associates.

“We’re the Rocaton of the West,” jokes Nesbitt, who, like the Rocaton partners, believes in doing the heavy lifting required to source and select single-manager and multistrategy hedge funds. “The trouble with traditional consultants is, they have not built that resource and level of expertise.”

RogersCasey co-founder Casey predicts that some consulting firms and funds of funds will team up. An early example was rolled out in May when Mercer Investment Consulting announced an agreement with Chicago-based HFR Asset Management that gives Mercer access to HFR’s research on single-strategy hedge funds. HFR offers investors access to managers willing to allow full transparency, daily pricing and risk monitoring. A team of 11 HFR researchers performs due diligence on several hundred of these funds from the firm’s proprietary database of more than 5,500 hedge funds. Mercer’s Americas business leader, Richard Nuzum, says his firm’s team of 44 manager-researchers will use HFR as one source of input into their own research.

“We are attracted by the transparency that the HFR platform offers, including the independent pricing, the independent custodian, the existence of risk-control guidelines for each fund and the conduct of daily risk monitoring by HFR,” he says. “We believe that gaining access to HFR’s research will help us better leverage our own investment in research to identify funds we are comfortable recommending to our clients.”

Not all consultants believe it is possible to do the work of funds of hedge funds by themselves. “Fund-of-funds fees are coming down, and consulting fees for absolute-return services are going up, but there’s still a justified spread,” says Alan Dorsey, head of alternative investments and research at CRA RogersCasey.

“Generally speaking, there’s danger in consultants pretending that they can do all the things a fund of funds does,” adds Dorsey, who joined RogersCasey after the Rocaton partners’ departure. “Consultants don’t have the staff or expertise and don’t have the economics to pay for staff and expertise.” Maureen Brille, a partner at the Gerson Group, an executive search firm in New York, estimates that a midlevel analyst at a fund-of-hedge-funds firm takes home between $300,000 and $500,000 a year including salary and bonus. At a consulting firm only partners can earn those kinds of salaries. Rocaton factored those economics into its business model by making seven partners full-time research specialists.

Future growth at Rocaton is unlikely to come from the public pension world, where many plan sponsors simply don’t have the interest in its ideas or the budget for its fees. Rocaton has only three public pension funds on its client roster. And those that it does have, like San Diego County, have a long history of embracing alternative investments. For a demanding client like San Diego CIO Deutsch, Rocaton is currently juggling hedge fund selection with monthly board meeting attendance, as well as assisting with a test of a “beta engine,” a collection of rules and signals that triggers tactical moves like overweighting or underweighting stocks and buying or selling futures for the county’s portfolio.

Aware of the feathers they have ruffled and motivated by the intellectual discourse they crave, the 16 partners at Rocaton plan to continue operating on what one competitor calls the bleeding edge of investment consulting. As Rocaton works to entice the 40 percent of its clientele that have not yet made the move into hedge funds or portable alpha, the partners can point to the experience of Shirley Shea DeJarnette for proof that perseverance pays off. DeJarnette, treasurer of the University of Missouri System, was a RogersCasey client since 1991. Her relationship with CEO Pellish brought her to Rocaton after it opened its doors.

“I don’t think there’s a week that goes by that I don’t speak with Robin,” says DeJarnette, who oversees Missouri’s $2.5 billion retirement fund and $832 million endowment. Prompted by Pellish while she was working at RogersCasey, the university board began looking at hedge funds almost a decade ago, but it wasn’t until November 2004 that the system finally dipped its toe into the water with a 2.5 percent allocation to multistrategy firms Ramius and Bridgewater.

The partners at Rocaton believe that for pension plans to be successful during the next five to ten years — with success being defined as preserving funded ratios and benefits for participants — plan sponsors will need to take risks to make money. The irony is that most pension consultants are not rewarded for taking risks, points out AQR’s Kabiller. The difference at Rocaton, he says, is that “they recognize that they need to take more risk.”

A Window into Rocaton

As chief investment officer of the Pennsylvania State Employees’ Retirement System, Peter Gilbert prefers to lead, not follow, his colleagues in the pension investing crowd. “We’re always in the vanguard,” says Gilbert, referring to his fund’s ongoing commitment to pursuing the latest alpha-generating strategies. PennSERS has $9 billion allocated to hedge funds — almost a third of its $30 billion in assets.

Gilbert’s investment history at PennSERS, one of the first clients of Rocaton Investment Advisors, provides a window into the evolution of the Norwalk, Connecticut–based consulting firm’s views on hedge fund investing. Gilbert made his first hedge fund allocation to four market-neutral, long-short equity managers in 1999 with the help of a couple of the Rocaton partners, who were then at Barra RogersCasey. But when the returns of these funds later proved to be too highly correlated to one another, Rocaton advised that PennSERS diversify the hedge fund allocation using funds of hedge funds.

“We started looking at funds of hedge funds in 2002,” says Gilbert, who hired his first fund-of-funds manager that year, New York–based Blackstone Alternative Asset Management. The next step was to construct a portable-alpha program. PennSERS uses hedge funds to generate alpha — pure positive returns above what it could get by investing in the broad market — and then adds that to the market return, or beta, that is created using swap contracts based on the Standard & Poor’s 500 Index.

The use of hedge funds with portable alpha has become a hallmark of Rocaton. The end of the U.S. equity bull market in 2000 boosted the popularity of portable alpha among pension plan sponsors looking for new sources of returns. Several of Rocaton’s bigger, more sophisticated clients, like PennSERS, already had hedge fund investments and began asking for more.

“Philosophically, people here bought into the concept [of portable alpha], and clients accepted it,” says Timothy Jackson, who heads hedge fund research at Rocaton.

As its clients grew more comfortable with hedge fund investing, Rocaton began moving them beyond funds of hedge funds, primarily to save money on fees. The firm began recommending multistrategy hedge funds, most of which employ a variety of traditional hedge fund techniques, like arbitrage and event-driven investing.

Last year PennSERS hired its first multistrategy managers: AQR Capital Management and Bridgewater Associates, which each received $375 million — one half of a $750 million allocation. In July of this year, Gilbert added a second portable-alpha program, this time tied to PennSERS’ international equity portfolio using Europe, Australasia and Far East index swaps. At the same time, fund officials gave an additional $2 billion to both new and existing hedge fund managers.

“Most hedge funds in portable-alpha programs are tied to domestic equity, but we use hedge funds to hedge some of the risk in other asset classes,” says Gilbert. Achieving a high level of diversification is a primary goal at the fund, which also has a 12 percent allocation to private equity and venture capital.

It’s fairly certain that even with $9 billion in hedge funds, Gilbert and his consultants at Rocaton will continue to challenge one another to source new investment ideas. “There’s value to being early,” says Gilbert. — F.D.

Picking Managers the Rocaton Way

Researching hedge funds is far trickier than analyzing traditional money managers. Sure, hedge fund strategies can be more complicated than those employed by long-only managers, but the bigger problem is simply finding hedgies. Unlike with traditional managers, whose every move is chronicled by database providers like eVestment Alliance and Morningstar, no one firm tracks all the 9,000 to 12,000 hedge funds that are estimated to be operating now.

“To this day there is no good centralized database,” says Timothy Jackson, head of hedge fund research at Rocaton Investment Advisors. His firm finds hedge funds the old fashioned way — by networking.

“We constantly work to make sure we have good networks and contacts in the industry,” says Jackson, who works closely with David Morton on hedge fund research. Jackson and Morton are two of seven partners on the manager research team headed by Roger Fenningdorf. (The firm has 16 partners in total.) Rocaton follows about 1,200 managers of all stripes on behalf of its 52 clients, who turn to their consultants for advice on a total of $250 billion in pension fund and other institutional assets.

Morton and Jackson receive many invitations to attend capital introduction meetings sponsored by prime brokers who showcase their hedge fund clients. The most useful of these events, says Jackson, promote emerging managers and generate lists of funds for further inspection.

Jackson tries to establish relationships with all the prime brokers. When he hears of promising new managers who have left established hedge fund firms to open their own shops, Jackson calls their prime broker to get their cell phone numbers, often before the new managers have even rented office space. For example, when Max Holmes left D.E. Shaw & Co. to form Greenwich, Connecticut–based Plainfield Asset Management in February 2005, Jackson was on him before he bought his first pencil. Plainfield was recently added to Rocaton’s list of recommended hedge funds.

No manager makes it onto the Rocaton buy list without the consensus of all 16 partners, says Fenningdorf, who has an MBA in finance and international business from Yale University. After graduation he joined RogersCasey, where he worked for eight years, becoming a managing director and head of manager research before helping co-found Rocaton.

When it comes to hedge fund selection, Fenningdorf says one of the keys to success is establishing an ongoing dialogue with managers. Fenningdorf, who has helped lead Rocaton’s movement from funds of hedge funds to more-complex structures like multistrategy funds, says his firm prides itself on its ability to read managers. “We look for somebody with an edge,” he adds.

That edge could be a result of better resources — either human or technological — or superior judgment. Rocaton looks for managers who have unique insight and are continually striving to innovate. Fenningdorf says that evaluating multistrategy firms is a particularly labor-intensive task because each strategy has its own portfolio manager and investment take.

Rocaton advises on more than $14 billion in hedge fund assets, creating something of an inducement for managers to approach the consultants. “We get deluged with this new hedge fund and that new hedge fund,” says Jackson.

Fenningdorf enjoys his perch as gatekeeper and leaves the door open to new hedge fund managers who seek access to the kinds of assets that the partners at Rocaton represent.

“Anyone can come in,” says Fenningdorf with a smile. “But we may not encourage them to come back anytime soon.” — F.D