When the Virginia Retirement System wanted an adviser to help it invest the first $300 million of a total of $1 billion authorized for hedge funds in June, it turned to one of the oldest and biggest firms in the business of running funds of hedge funds, Ivy Asset Management Corp. of Garden City, New York. “Ivy has been in the business for a very long time, and this is a relatively new business for institutional investors like VRS,” says Nancy Everett, chief investment officer of the $36 billion Virginia plan.
VRS joins a growing number of U.S. pension plans -- such as the California Public Employees’ Retirement System, the Pennsylvania State Employees’ Retirement System and International Paper Co. -- that are gaining exposure to absolute-return strategies through funds of funds. And though inflows from pension funds promise to swell the coffers of multimanager hedge funds over the coming years, so far, at least, that money seems to be going to a relatively short list of large firms, including Ivy.
Even so, U.S. defined benefit plans today trail endowments and foundations in terms of hedge fund exposure. An autumn 2002 study by consulting firm Greenwich Associates found that 58 percent of U.S. endowments had invested in hedge funds, compared with only 11 percent of U.S. corporate pension plans and 8 percent of public pension funds. A recent survey by Goldman Sachs International and Russell Investment Group reported a median hedge fund allocation by North American corporate plans of 3.0 percent at the end of 2002, while the public plan median allocation was 1.9 percent. But the number of plan sponsors searching for absolute-return managers is growing fast.
“We’ve been very busy,” says Timothy Jackson, a partner specializing in alternative investments at institutional investment consulting firm Rocaton Investment Advisors in Norwalk, Connecticut. “The pace experienced over the past couple of years has not slowed at all through 2003.”
This year’s strong stock market returns notwithstanding, plan sponsors expect “very, very modest returns out of the equity markets over the next five to ten years,” says Jackson. With interest rates at historic lows and the pain of last summer’s spike in bond yields -- the ten-year note’s yield jumped from 3.10 percent in mid-June to 4.60 percent around Labor Day -- fresh in their minds, plan sponsors are worried about meeting their retirement liabilities and don’t expect much better from the fixed-income markets. “Over the past three years, people realized the benefit of having an absolute-return, noncorrelated strategy as a piece of their portfolio,” Jackson says. Hedge Fund Research’s index of fund-of-funds returns rose 1.02 percent in 2002, while the Standard & Poor’s 500 index gave up 23 percent. Through the first three quarters of 2003, the Chicago hedge fund database firm’s fund-of-funds index rose 7.4 percent, compared with an increase of 13 percent for the S&P 500.
Meanwhile, continued interest among institutions and wealthy individuals has bolstered the assets run by funds of funds. Money managed by the constituent firms of Alpha ‘s 2003 Fund of Funds 50, our second annual list of the 50 largest multimanager hedge fund families, exceeded $211 billion as of June 30, 2003, up 24 percent from the year before. That amounts to almost one third of total hedge fund assets of $670 billion as of the end of first-half 2003, according to estimates by HFR, a sister company to fund-of-funds manager HFR Group (No. 48 in our ranking).
The top 50 firms are led by Zurich-based UBS, which runs $17.5 billion in funds of funds through four business units. UBS rises one spot to overtake last year’s leader, London’s Man Investments, in second place this year with more than $15 billion in multimanager hedge fund assets run through Chicago-based Glenwood Capital Investments and RMF Investment Management of Pfäffikon, Switzerland. Debuting this year at No. 3 is HSBC Private Banking Holdings (Suisse), headquartered in Geneva, which runs more than $9 billion, most of it in advisory mandates. Rounding out the top five are Seattle’s Quellos Capital Management, repeating in fourth, and Ivy, rising two notches from last year. “There is tremendous pent-up demand for institutional-quality funds of funds, so I see demand accelerating for top-tier firms,” says Carrie McCabe, president of McCabe Advisors, a New York adviser to hedge funds and their investors.
The biggest firms aren’t necessarily growing the fastest. Lighthouse Partners of Palm Beach Gardens, Florida, which rises from No. to No. 29, saw assets more than double, to nearly $2.9 billion, over the 12 months through June 30, causing the firm to close its Super Cash and Diversified strategies to new investors. “I think institutional consultants, particularly, appreciated our willingness to close and our focus on investment management and not distribution,” said Dana Hall, managing director and director of strategic planning at Lighthouse. Seattle’s Silver Creek SV, unranked last year, finishes at No. 41 with $1.8 billion, up almost 90 percent from June 2002, and HFR Group’s assets grew some 80 percent year-on-year. New York’s Blackstone Alternative Asset Management, which rises from No. 15 to No. 7, saw its assets jump 63 percent, to $7 billion; and Geneva’s Unigestion (No. 39, up from No. 47) saw assets increase by 67 percent, to about $2 billion.
Pension plans making their first forays into hedge fund investing often do so through funds of funds. Some plan sponsors -- including VRS -- hire fund-of-funds managers as advisers to help with manager selection, investment monitoring and risk management, while investing directly with single-manager funds. Others place money in funds or separate accounts run by the fund-of-funds manager. Either way, a few large managers are attracting most of the pension cash. Among the Fund of Funds 50 members most successful at securing pension mandates: Blackstone Alternative; Harris Alternatives of Chicago (No. 24); Ivy; Chicago’s Mesirow Advanced Strategies (No. 25); Northwater Capital Management of Toronto (No. 23); Pacific Alternative Asset Management Co. of Irvine, California (No. 22); and Tremont Capital Management of Rye, New York (No. 16). Other firms that derive a significant chunk of their assets from U.S. pension clients include Arden Asset Management of New York (No. 30); Chicago-based Grosvenor Capital Management (No. 12); Morgan Stanley Alternative Investment Partners of West Conshohocken, Pennsylvania (No. 21); and Quellos. (For more information on sources of assets, plus data on expenses and returns of individual funds of funds, please visit the Alpha Web site, www.institutionalinvestor.com.)
What these firms have in common is size: All run several billion dollars and can therefore afford to hire highly paid staff with the experience and qualifications to perform manager research, risk monitoring and client service. Blackstone Alternative, for example, employs more than 43 investment professionals. “Our focus is to hire individuals with trading or risk management expertise coming right out of securities firms, and these people have been very much in demand,” says J. Tomilson Hill, Blackstone Alternative president and CEO.
Size confers other advantages on managers, such as the ability to offer customized portfolios and to navigate the complexities of ERISA compliance. “Unless you’re running north of a billion dollars, you are not going to be in a position to offer the type of quality program that a pension investor is going to require,” says Averell Mortimer, president of Arden.
Yet smaller firms do draw pension mandates. VRS, for example, hired Washington, D.C.based Rock Creek Group in August to advise it on a second tranche -- of $200 million -- in hedge fund assets. Although Rock Creek runs only $650 million, the firm’s principals once ran the World Bank’s pension fund.
If current trends continue, there is more growth in store for both multimanager and single-manager funds. VRS has an additional $500 million authorized for hedge fund investment if the plan can find good individual hedge fund managers. Eventually, as other institutions become more sophisticated, they may venture out to invest in single-manager funds directly, as a complement to their multimanager portfolios. Says Rocaton’s Jackson, “We are actually seeing institutional clients that have been invested in funds of funds for some time taking the next step and going to single-manager funds.”
Click here to view the complete Fund of Funds 50 ranked list.
