Pensions Move to Direct Hedge Fund Investments?

Before getting into my latest topic, I want to thank those of you who took the time to write me after reading my last comment on the ugly truth. Rest assured this blog is not my open diary but sometimes I like delving deep into personal matters because I believe certain frustrations, anxieties and worries are common and if by expressing my thoughts, I can help someone else, so much the better. I have nothing to ashamed of and if some people choose to use my openness against me, then shame on them. The real ugly truth is that far too many people in finance and business are money whores and would screw over anyone for money. That's all I'll say about the ugly truth.

Now, onto the latest topic, direct investments into hedge funds. Christine Williamson of Pensions & Investments reports, Move to direct hedge fund investments boosting business for consultants:

The pace of searches and hires is up sharply this year for specialist and general consultants advising institutional investors on direct hedge fund investments.

That increase is the result of the trend toward direct investment in single and multistrategy hedge funds and away from hedge funds of funds, especially by large public pension funds, industry insiders say.

Among the pension funds that hired their first consultants for specialist hedge fund and alternative investment assignments so far this year:

• The $23 billion Employees Retirement System of Texas, Austin, hired Albourne Partners Ltd. in May.

• The $49.5 billion Massachusetts Pension Reserves Investment Management Board, Boston, hired Cliffwater LLC in April.

• Trustees of the $76 billion Ohio Public Employees Retirement System, Columbus, hired Hewitt EnnisKnupp in April for alternative investments, including hedge funds, but also signed a contract with Cliffwater to provide non-discretionary operational due diligence for a new $1.2 billion direct investment program.

• Three of the five pension funds in the New York City Retirement Systems — the $24.3 billion police fund, the $7.9 billion fire fund and the $41.2 billion employees' retirement system — hired Aksia LLC in January.


“In the last 18 months, a lot of the groundwork has been laid through intensive education for public and corporate pension plan trustees, and now, clients are beginning to implement their direct investment programs in hedge funds,” said Mary Bates, a senior hedge fund consultant in Hewitt EnnisKnupp's Chicago office.

Market observers said the pace of direct investment will accelerate further as more experienced hedge fund investors pump more money into hedge funds. For example, staff of the $109.1 billion Texas Teacher Retirement System of Texas, Austin, recently received legislative approval to double the hedge fund limit to 10% of plan assets. Texas Teachers' hedge fund assets totaled $4.06 billion as of March 31.

The $51.2 billion Pennsylvania Public School Employees' Retirement System, Harrisburg, also increased its hedge fund target to 12% of plan assets from 10% in March; hedge fund assets totaled $4.92 billion as of March 31.

For advice on direct investments, Texas Teachers' investment staffers rely on specialist hedge fund consultant Albourne Partners; Pennsylvania Schools officials use Aksia.

A chosen few

A handful of sophisticated specialist consultants and a few general consultants are winning most of the new assignments as well as retaining existing clients or, increasingly, snatching clients away from each other, according to a review of reported searches and hires in Pensions & Investments' archives.

The top specialist alternative investment consultants include:

• Albourne Partners, which advised 202 clients on $230 billion in hedge fund investments as of May 31.

• Aksia, which advised 42 clients with $42 billion as of April 30 in hedge fund investments.

Cliffwater, which provided customized consulting services to 27 clients with $19 billion invested in hedge funds as of May 31.

The Beryl Consulting Group LLC also offers clients both basic research and highly customized portfolio services.

General investment consulting firms with a reputation for robust hedge fund expertise include Cambridge Associates LLC, NEPC LLC, Hewitt EnnisKnupp, Rocaton Investment Advisors LLC and Fund Evaluation Group LLC.

Specialist hedge fund consultants are at “the leading edge of the phenomenon of many pension plans, especially public plans, moving to direct hedge fund investment,” said David Harmston, partner and global head of Albourne Partners' client group. Mr. Harmston is based in the London-based firm's Norwalk, Conn., office.

Each of the specialist consultants offers different services and specializations in combination, ranging from manager research and due diligence reports to highly customized portfolio construction, including manager selection as well as negotiation on fees and terms.

For larger funds, like Texas Teachers, Albourne Partners' in-depth, extensive research on hedge fund managers has served the fund well since 2005.

During a June 16 board meeting discussion about renewing the Albourne contract, Jerry Albright, deputy chief investment officer, told trustees: “I can't imagine running this portfolio without them. It would be devastating to lose Albourne.”

The Pennsylvania Schools fund is one relying on a more collaborative relationship with specialist consultants for hedge funds, private equity and real estate.

“We view our consultants as an extension of our investment staff,” said Alan Van Noord, chief investment officer. “It's like a basketball team: Our staffers are the starters, and the consultant is the sixth man, getting a lot of playing time.”

With an additional 2.3% or about $1.2 billion to put to work in new direct hedge fund investments under the fund's new asset allocation, Mr. Van Noord said Aksia and investment staff will gradually add new managers. The fund also is considering adding emerging hedge fund managers.

Many large plans are moving fast into direct investments. According to FinAlternatives, Ohio Pension Eyes Hedge Funds For $1.2B Buy:

The Ohio Public Employees Retirement is poised to make its first foray into single-manager hedge funds a big one. The $76 billion pension plans to invest about $1.2 billion in single and multi-strategy funds in the third quarter, Pensions & Investments reports.

The move follows OPERS’ investment of $700 million in funds of hedge funds last year. The pension boosted its allocation to hedge funds to 3% last year, as well.

OPERS will not issue requests for proposals; instead, the pension has asked interested managers to contact the system directly. Those interested managers should have at least $1 billion in assets under management.

Hedge fund consultant Cliffwater will assist the pension in due diligence and will recommend managers to OPERS. The first round of funds is expected to be completed during the third quarter of the year.

I already shared my thoughts on public pensions betting the farm on hedge funds. Is it better to use "specialist consultants" over funds of funds? That really depends on the size and experience that pension funds have with hedge funds. I know of very large hedge fund programs where they use specialist consultants, fund of funds, and specialized capital introduction people (if you are a US fund, contact me and I will be glad to share some names with you of independent, qualified hedge fund consultants with years of experience.)

I'm also toying with the idea of "specialized consulting" on hedge funds and thinking of teaming up with friends who are experts in operational due diligence, performance, risk management, and ripping apart hedge fund strategies to see who is truly delivering alpha and who is selling beta as alpha. My biggest fear with this rush into hedge funds is that far too many institutional investors will get bad advice, are not mindful of conflicts of interest and will find refuge by investing in "brand names" even if this isn't in their best interest. For example, I believe if done properly, public pensions can benefit enormously by seeding hedge funds.

After my last post on betting the farm on hedge funds, I received this comment from a senior pension fund manager from a large US plan:

Hi, Leo - thanks for posting the article. I wish you'd provided more commentary, because there's a lot to be said about pension plans investing more in hedge funds. (Then again, I know you've commented extensively on the topic elsewhere.) A key question: what is a 2-5% allocation to HFs really going to do for a plan's overall risk/return profile? (We're at 2.5% and are always having this discussion. As well we should. But I'm not sure others are.)

He's absolutely right. Don't just follow the pension herd into hedge funds. You can use specialist consultants as an extension of your investment staff but at the end of the day, they want you to invest in hedge funds because that's their bread and butter. Very few will stop and have a critical discussion with you as to how hedge funds fit into the overall portfolio and whether or not you should be investing in hedge funds to begin with.

This is where I will make my shameless plug. I have close friends in Montreal with extensive experience covering all aspects of hedge funds. Moreover, despite what people think, I'm not horny for hedge funds and will give it to you straight on how you should invest in them properly covering all risks, including operational and liquidity risks, not just investment risks. Feel free to contact me at and let me at least share some thoughts on how to conduct a proper due diligence on hedge funds and fund of funds, explaining what you should steer clear of even if "specialist consultants" are telling you otherwise. Again, if done properly, hedge funds can add value to your overall pension portfolio, but if done poorly, they will come back to haunt you.