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ALTERNATIVES - Down, But Not Out

Why Massachusetts' PRIT believes that now more than ever, hedge funds are the route to growth.

THE PENSION RESERVES Investment Trust Fund, Massachusetts’ state pension fund, hasn’t had much luck with hedge funds of late. The September 2006 blowup of Amaranth Advisors cost the plan $50 million. Then, when this summer’s subprime market meltdown led to the collapse of Sowood Capital Management, yet a further $30 million vanished from the pension fund’s alternatives portfolio. Nonetheless, Michael Travaglini, head of the Massachusetts Pension Reserves Investment Management board, which oversees PRIT’s $50 billion portfolio, is not wavering in his dedication to hedge funds.

“We don’t want to minimize the fact that money was lost, but if you look at it within the context of a $50 billion pension plan, it doesn’t justify retreating from the asset class,” says Travaglini. “If we owned Google and the stock suddenly dropped, we wouldn’t abandon domestic equities altogether.”

Posting double-digit gains on behalf of 80,000 active workers, retirees and beneficiaries is no easy task, but since Travaglini took over as executive director in 2004, PRIT has managed to do just that. Travaglini, who previously served as a senior vice president and relationship manager for Boston-based Putnam Investments’ defined benefit accounts, has increased the plan’s hedge fund allocation to 10 percent of the portfolio through a combination of absolute-return and portable-alpha strategies. The plan is currently invested in eight funds of hedge funds with strategies including relative value, event-driven and global macro.

Travaglini has also bolstered the plan’s exposure to high-yield bonds, timber, real estate and emerging-markets investments. All of that has helped PRIT generate a three-year annualized return of 16.25 percent as of June 30, ranking it in the top 2 percent of public funds nationwide, according to Santa Monica, California–based Wilshire Associates’ Trust Universe Comparison Service. And despite the losses incurred because of Sowood’s collapse, the fund was up 11.50 percent for the year through September, well above its full-year target of 8.25 percent.

“Every basis point above that benchmark is a dollar that the state doesn’t have to appropriate on our behalf,” says Travaglini. Massachusetts has shied away from direct hedge fund allocations, instead favoring funds of hedge funds as a way to keep volatility down. PRIT’s Sowood exposure was through a $525 million allocation to New York–based fund-of-funds firm Arden Asset Management.

Though Travaglini is standing by his commitment to hedge funds, he says that PRIT has not lost sight of the risks involved with investing in them, and the possibility of losing a large part of its alternative allocation is his biggest concern. “Sowood was there, and now it isn’t,” he says. “And it was the same thing with Amaranth — one day it was a $10 billion enterprise, and the next day it vanished.” PRIT’s investment in Amaranth was through funds of hedge funds managed by Ivy Asset Management Corp. and Rock Creek Group.

Such calamities have opened PRIT’s hedge fund investments to scrutiny. William Galvin, Massachusetts’ secretary of state, has criticized the fund’s use of hedge funds for the retirees. Travaglini says he understands such skepticism but believes that critics such as Galvin have often been guilty of “overreaching.”

After the failure of Sowood, PRIT held discussions with Arden to determine the lessons the firm had learned and what internal steps it had since taken from a risk management perspective. The plan also wanted to ensure that Arden wouldn’t unnecessarily reduce exposure to any single fund as part of a knee-jerk reaction to Sowood.

When it comes to management of a fund of PRIT’s size, says Travaglini, investors need to keep things in perspective — which means not getting caught up in short-term aberrations. “When someone asks about a particular part of our portfolio, we’re happy to talk about it,” he says. “At the same time, we remind them that it’s the bigger picture that’s really important.”