Why Would a Huge, Shrewd Allocator Hire a Fund-of-Hedge Funds?

The Florida State Board of Administration (SBA) did something unusual this spring: It committed $150 million to a fund-of-hedge funds, on top of the $300 million it already invested.

“JP Morgan [Asset Management] came to us with the concept of investing in new machine learning funds and asked if we’d be interested,” senior investment officer Trent Webster said in an interview Friday. “And we said yes.” 

The funds-of-funds model has gone deeply out of fashion over the past decade or so, as institutions learned to pick their own hedge funds directly and skip the vehicles’ extra fee layer. Florida SBA — which manages $209 billion in state assets — is one such institution. “Generally, we’ll do it ourselves,” Webster said.

JPMAM’s Elan Fund is one of only two funds-of-hedge funds remaining in SBA’s portfolio, Webster said. BlackRock runs the other one, and each distributes about $400 million to $450 million to quantitative managers on SBA’s behalf.  

The $150 million machine-learning play aligned with the overall mandate of Webster’s “strategic investments” unit: reduce equity risk. Accessing these esoteric managers via the Elan Fund was more efficient than going direct, he said. “We did it that way to get a significant allocation quickly at the time, rather than build up the expertise.” 

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SBA does have PhDs and quants on staff, Webster added, and has transitioned from funds of funds to direct for certain categories. 

In late 2014, for example, the team made its initial $300 million Elan Fund commitment, hiring JPMAM to build it a portfolio of managed futures and quantitative strategies, SBA documents show. Since then, “We’ve told our funds of funds to go out and find the more specialized managers. At CTAs” — commodity-trading advisors — “the fee structures are changing such that it’s becoming economic to do it directly. We’re starting to allocate to the commoditized strategies, and letting the fund of funds focus on the more specialized areas.” 

CTAs and managed futures have had several years of rocky performance. The Elan Fund delivered somewhat better returns than average — 4.3 percent annualized as of the end of 2018, according to an SBA report. “For us, it’s been OK,” Webster said.

The often-complex products make sense for an equity-diversification mandate, explained Frans Harts, a partner at CTA shop KeyQuant. The French firm runs $430 million in assets, about half of them for U.S. clients. “Managed futures don’t have a bias towards an asset class. They trade currencies, equities, bonds, currencies — and within those different markets, they can be long or short.” 

“If you’re concerned about having a strategy that will potentially do well in a medium to long-term reversal in equities or bonds, CTAs are a good fit,” Harts said Friday by phone from France. “If there’s a reversal that’s unexpected — such as in January and February of 2018 — you’re going to feel that pain.”