After years of lagging returns, some asset owners have cut back their hedge fund exposure in favor of better-performing private assets.
But the University of Nebraska Foundation has gone a step further. In 2020, the $2 billion foundation completely jettisoned its hedge fund portfolio, which made up roughly 15 percent of its endowment.
Even though hedge fund returns are bouncing back — a PivotalPath index showed that last year the industry posted its best performance since 2013 — the foundation’s investment chief Brian Neale said the decision is working out well so far.
“Honestly given the hedge fund returns over the last year, you could make the argument of whether now is the right time,” Neale said over Zoom. “I’d say yes. Sell high, right?”
The foundation’s decision came after an internal asset class review. Although its hedge fund allocation was “hitting all of its marks,” Neale said that the resources the university was spending to manage those investments weren’t paying off.
“Fees being what they were, that played into the conversation, especially as we saw absolute returns coming down over time,” Neale said. This, coupled with the fact that hedge funds are posting lower average returns than private or public equities, made the decision to nix the allocation attractive.
The other thing that the foundation considered was how its investment team members were spending their time. Neale, who has been the foundation’s investment head since 2014, works alongside a small team. And although just 15 percent of the foundation’s endowed portfolio had been invested in hedge funds, he said that fund selection, due diligence, and management of hedge funds were taking up a significant chunk of their time.
“Were we getting the most bang for our buck?” Neale asked. “The short answer is no, probably not.”
This was made all the more painful when the university was cut out of the deals it spent a long time researching. According to Neale, the foundation spent a year and a half on due diligence for a certain hedge fund investment, only to be put on the waitlist. Just a year after they finally invested, the hedge fund firm announced it was converting to a family office.
This wasn’t a one-off case — Neale said it was one of three recent experiences in that vein.
Ultimately, however, the decision came down to prospective returns.
“The impetus for the final move was based on our forward-looking assumptions,” Neale said. “Just looking out into our crystal ball so to speak, rightly or wrongly we found that a diversified hedge fund program is probably not going to be as accretive to achieving” the foundation’s targeted annual return.
The redemptions began in March 2020. During that time, Neale contacted each of the portfolio’s managers and walked them through the decision-making process. A few of the hedge funds managed other assets for UNF, which made preserving the relationship even more important.
“We want to be a good partner on the way out,” Neale said. “Nobody likes to see assets walk, but when people hear a sound rational approach it makes things better.”
The redemption process is about 95 percent complete, and UNF has reallocated the funds to real assets and private equity. Neale is quick to note that he isn’t characterizing hedge funds as bad — and that UNF hasn’t outright banned hedge funds. In fact, the foundation’s investment policy statement allows the organization to start investing in those vehicles again, should the market change.
“That’s really important because as an institution with perpetual capital, we want to maintain open-mindedness with hedge fund strategies,” Neale said.
He added that the foundation is also considering how it may handle a downturn moving forward.
“We’re not obtuse to the fact that we’re unhedged,” he said, adding that his team has spent the past six months looking at everything from overlays to outright tail-risk strategies.
“We haven’t landed on any specifics yet, but there’s pros and cons,” Neale said. “Running the hedges internally is a possibility, but we’re not as well-resourced as some organizations. It’s an option that we’re looking at, no pun intended.”