Harvard Doubles Down on Hedge Funds

Bloomberg reports that Harvard endowment’s CEO N.P. “Narv” Narvekar is doubling down on hedge funds:
Narvekar’s bet on the sophisticated, high-cost brand of money manager marks the biggest since the university hired him in 2016 to turn around the lagging performance of its $39 billion endowment.

Over the two years ended in June, the largest fund in higher education almost doubled its investment in hedge funds, which now total $13 billion, university filings show. Harvard’s hedge funds comprise a third of the endowment, compared with roughly a quarter at Yale and Princeton.

Hedge funds have had years of uneven or poor performance during a long bull market that has favored low-cost investing in market indexes. Their returns and fees -- traditionally 2 percent of assets and 20 percent of profits --- have frustrated many other institutions. A third of U.S. endowments and foundations anticipate allocating less to hedge funds this year, according to a survey last month by consultant NEPC.

To achieve his mandate of beating his peers, Narvekar appears to be making a contrarian move that could pay off if stocks head south.

“He’s trying to position the portfolio for the next market cycle,” said Laurence Siegel, former head of investment research at the Ford Foundation. “Any good manager should be doing that.”
Indeed, it looks like Narvekar is calling a market top and thinks that going forward, alpha is worth paying for because the big beta thrust is over.

The reliance on external hedge funds marks a major shift at Harvard's mighty endowment. Prior to Narvekar's arrival, Harvard had been unusual among major endowments because it had managed much of the money in-house.

In fact, some of its portfolio managers -- who could earn millions, even tens of millions, a year -- in a sense operated in-house hedge funds and private equity funds.

For example, Dan Cummings, the endowment's former head of real estate, received $23.8 million in 2016, making him the highest-paid employee at the endowment in a period when the fund trailed peers. Cummings left Harvard in 2018 to join the team he led to Boston-based private equity manager Bain Capital.

Bloomberg states that Harvard is now following the model of Yale, focusing on hiring only the best external money managers. It is mining its existing hedge fund portfolio, allocating more money to top performers while chasing established and emerging stars:
Narvekar and his team have put money into managers launching new funds. They include Dan Sundheim’s D1 Capital Partners. Sundheim, former chief investment officer of stock-focused Viking Global Investors, broke out on his own two years ago, saying he wanted a more flexible trading mandate.

Harvard has also committed more money to funds already in the portfolio such as health care specialist Deerfield Management, which invests in public and private equities, according to people familiar with the matter.

For Narvekar, who declined to be interviewed through a spokesman, hedge funds have long represented a favored strategy. They still make up a third of assets at Columbia University, where Narvekar worked for 11 years before heading to Harvard.

Narvekar and his team are targeting managers with a variety of styles, such as long-short equity, D1 Capital’s approach. A classic hedge fund strategy, it’s designed for returns that are less correlated with the stock market. Investors balance bets on stocks deemed likely to rise with those expected to fall.

D1 also takes stakes in private companies, which are often available at discounts to public ones. The fund gained 10 percent in the first two months of this year, after returning 5.4 percent last year.

Harvard backed MFN Partners Management, co-founded two years ago by Michael DeMichele, a former partner at Baupost Group, according to a person familiar with the matter. Famed value investor Seth Klarman runs Boston-based Baupost. Value investors bet on beaten-down investments in the hope of a rebound.

One winning wager has been Jeffrey Talpins’s Element Capital Management, which Narvekar backed while running Columbia’s endowment. The New York-based company uses a global macroeconomic strategy: trades based on political and economic trends, rather than the fundamental analysis of individual investments.

The fund surged 17 percent last year while producing annualized gains of 21 percent since launching in 2005. Element paid Talpins $420 million last year, among the most of any hedge fund manager.

Harvard still has faith in some of the investors who ran money internally. It seeded some former employees who launched funds after Narvekar trimmed operations. TPRV Capital, for one, specializes in relative value. That approach tries to take advantage of price discrepancies of related securities, such as stocks in the same industry.
But the shift toward hedge funds hasn't really helped thus far. Harvard gained 10 percent in the year through June 30, 2018, trailing all Ivy League peers except Columbia, Narvekar’s former employer. Over the decade ended in June, it had the worst results, an average annual return of 4.5 percent. Columbia gained 8 percent a year, tied for the Ivy League best.

Whether or not hedge funds help Harvard regain its edge remains to be seen, but at the beginning of 2018, I told my readers it's time to look at hedge funds again.

The problem is finding the winners and losers ahead of time and that's not easy in this environment. The Wall Street Journal just reported that even though it's tough times for hedge funds, some do stand out. And it's not just the large brand name funds:
Some large, venerable managers certainly are still doing well, including Renaissance Technologies’ $27.1 billion equity fund (up 15.34% based on trailing five-year net annualized returns); the $18 billion global macro fund Element Capital (up 13.28%), which targets investments triggered by shifts in key economic indicators; and Citadel’s $19.3 billion Wellington multistrategy fund (up 11.86%). All those returns since the beginning of 2014 are well above the market’s annualized gain of 8.49% over the same period.

Still, of the 60 established diversified funds in the review with the best five-year returns, more than half are managing less than $1 billion.

MMCAP out of Toronto, for example, has $621 million in assets but has generated returns of nearly 28% a year since the beginning of 2014. The fund’s “event driven” strategy typically seeks out opportunities related to events like mergers and corporate structure, and also engages in private investments.

Hong Kong-based KS Asia Absolute Return, a $720 million multistrategy fund, is delivering annualized returns of more than 20%. New York-domiciled MAK One ($458 million), which targets distressed credit and equity opportunities, has been realizing returns of nearly 19.5% over the past five years.

The managers of these three funds declined to be interviewed for this article. But a co-manager of another of the smaller funds, Amin Nathoo at the $354 million hedged-equity Anson Investments Master Fund, says, “We’re able to more quickly respond and profit from opportunities across all segments of the market than much larger funds that can’t establish sufficient exposure in smaller-cap shares.”

Anson returned more than 19% last year and has racked up net annualized gains of 11.8% since its launch in July 2007, compared with 6.8% for the S&P 500.
The article also cited another smaller Canadian hedge fund manager which is performing well over the last five years and is postioned more defensively here:
“All the things that worried the market in the fourth quarter last year are still with us,” says Hanif Mamdani, manager of the PH&N Absolute Return fund, which was up 10.4% over the past five years. While he thinks the Fed’s U-turn on raising interest rates has bought the bull market a few more quarters, he says investors need to cautiously diversify beyond securities that have been performing well.

He cites historical research showing the most difficult credit markets come in situations similar to the one we’re in now, when central banks pause rate increases and start considering reversing policy. When this factor is combined with a long rally and various macro concerns ranging from slowing economic growth to expanding trade conflicts, it compels Mr. Mamdani to become more defensive.
Mamdani is right about being defensive but I'm amazed at how strong momentum strategies still are.

Today, I hooked up for lunch with Pierre-Philippe Ste-Marie, CIO of Optimum Asset Management here in Montreal. The firm manages $8 billion, mostly in fixed income but they do have some equity  and absolute return strategies run by Pierre-Philippe and his team (they are performing very well).

Pierre-Philippe is a very smart guy. We went to McGill at the same time, took some honors economics courses and then he went on to Carnegie Mellon to complete a Master of Science in Computational Finance while I stayed at McGill to complete my M.A. in Economics.

Before joining Optimum, he had founded a small hedge fund in Montreal, Razorbill Advisors, and before that, he was managing the credit derivatives desk at the National Bank and printing money.

Anyway, we were talking about factor investing and how it's gotten whacked so hard. I told him everything is about momentum these days. He told me they have a momentum component in their analysis but over the long run, fundamentals matter and value investing will come back.

Then we spoke about the collapse of trade talks between China and the US. He said the "market isn't buying it" as it came back strong today.

But on Friday evening, I dined with a friend who also studied economics at McGill right after us and then ended up trading at Millennium, one of the best multi-strategy hedge funds in the world. He and his partner are running their own small macro fund now.

He was telling me that "Trump is the best macro trader ever" and that a friend of his looked at all of Trump's tweets and whatever he says "ends up being true" (for markets, not politics).

So this morning, when Trump tweeted this out, it was very concerning:

My friend told me: "This is Trump 101. The trade deal is done."

What else did he tell me? If you look at hedge fund beta, it's at its lowest in years, and that's across strategies, including CTAs:

So, hedge funds aren't chasing beta here, they're waiting on the sidelines and if the market keeps grinding higher, many will continue to underperform.

However, if the trade talks collapse, then maybe that will be the catalyst for the next downleg.

We shall see. My friend did share something else, namely, to expect a massive infrastructure deal in the US before the next election. "Trump wants $1 trillion, the Dems want $2 trillion, watch it be $3 trillion and they will figure out how to pay for it later. Start buying steel and copper stocks here."

And he told me that Ray Dalio is right, something like MMT is coming whether we like it or not and to read Bain's report, A world awash in money, it's excellent and he spoke very highly of Karen Harris.

Lastly, while we are on the topic of hedge funds, Bloomberg recently reported that hedge fund co-investing is becoming more popular.

Co-investing makes sense in private equity and it can work for some highly liquid and scalable hedge fund strategies, but it's not the same thing as co-investing alongside a private equity partner.

By the way, Warren Buffett slammed private equity over the weekend, stating this:
“We have seen a number of proposals from private equity funds where the returns are really not calculated in a manner that I would regard as honest,” Buffett said Saturday at Berkshire Hathaway Inc.’s annual meeting. “If I were running a pension fund, I would be very careful about what was being offered to me.”
This explains why Harvard's endowment isn't doubling down on private equity at this point of the cycle but is ramping up its allocation to hedge funds.

Below, a clip from the Milken Institute Global Conference on the hedge fund shakeout. Narv Naverkar and his team at Harvard don't seem phased by all this hedge fund shakeout talk and neither should you if you know how to conduct a proper due diligence (that's another topic for another day).