In today's high-volatility/low-return market, Scott Schweighauser said institutional investors should not be asking whether they should invest in hedge funds, but rather how large of an allocation they can make to the asset class. Mr. Schweighauser, chief investment officer at hedge funds-of-funds firm Aurora Investment Management LLC, and Roxanne Martino, CEO, are confident in their ability to identify the top hedge fund talent and produce what investors need in this day and age — solid returns with low volatility. When other funds-of-funds firms were seeing large redemptions following the financial crisis, Aurora lost 8% through redemptions and was already looking to deploy its capital in the next big opportunity. “In some ways, market events are healthy because it compels people to recalibrate their approach to evaluating and managing risk in their portfolio,” Ms. Martino said.
Hedge fund opportunities might change depending on market events, but the senior team and investment process at Aurora has been a constant. Ms. Martino helped start the flagship multistrategy Aurora Limited Partnership Fund in 1988 as a two-year joint venture between Grosvenor Capital Management LP and Harris Associates LP. Ms. Martino left Grosvenor for Harris in 1990 and has managed the Aurora funds ever since. The Aurora funds team spun out to become Harris Alternatives LLC in 2003 and was rebranded Aurora Investment Management in 2009. Mr. Schweighauser joined the firm in 1994.
The firm's employee base has grown fourfold in the past 10 years, but the pair, along with their other two lead portfolio managers — Justin Sheperd and Peter Hamet — still perform the primary due diligence.
How has Aurora changed since the financial crisis?
Mr. Schweighauser: One of the allocations of capital within our multistrategy portfolio is what we call portfolio hedge. We've always had this component in our portfolio. ... It's there to help minimize exposure to the market, dampen the correlation that might arise from time to time within the strategies. Pre-2008, that component of our portfolio was comprised of dedicated short sellers who specialized in identifying companies that were fads, frauds and failures, basically. The short-sale ban in September 2008 really upended their ability to operate as they needed to operate. ... If the regulatory authorities have the ability to do that, we have to factor that into how we think about the portfolio in the future. So we went to a three-pronged approach in our portfolio hedge. We diversified into tail-risk strategies and managers that trade in instruments and strategies that will have very non-linear, very convex payoffs if we encounter another 2008-like crisis environment. We've also added a component of futures and options to that portfolio hedge component.
Where do you see the best investment opportunities?
Mr. Schweighauser: Right now, the world is fraught with uncertainty and it has been for a while. Our view is we want to emphasize managers that have a lot of flexibility to take advantage of the macroeconomic themes and trends that are in the market today and are likely to persist for quite a long period of time. We have a component in our portfolio called global macro that we increased and will continue to emphasize. And then, within macro we have different areas — emerging markets, commodities, traditional global macro, CTAs — so it's a very diversified approach. The principal advantage is they can move very quickly, can be long and short, and can be in all the major asset classes. One of the themes that has been in our macro sector has been (to) short the euro because Europe is in trouble. The likelihood is that the euro will have to go lower relative to the major currencies in order to provide a better equilibrium for their economy. ... It's volatile, but it's been a profitable position.
What's the biggest effect on the industry from new regulations?
Ms. Martino: I would say talent into the business. With the Volcker rule, so many large financial institutions had to eliminate their own trade center. So what we've seen is migration of full teams into our industry. For us, whole team liftouts are always very interesting. So much of the unknown about a new team starting a hedge fund is known when they have worked together before — there's a hierarchy, there's a leader, you can trust them and they have operated in the same sector before. So for us, team liftouts are a great opportunity to look at good talent that has been together for a long time. ... In some ways, the regulations have been a boon to our industry. ... We've seen a ton of talent.
Do you view the new regulations as a boon for the individual hedge fund managers, too?
Mr. Schweighauser: It's funny. The hedge fund industry is always in a process of constant change and a process of reinvention. It's one of the great manifestations of pure capitalism because it's a meritocracy. If you don't make money, you won't survive. People vote with their feet. If you have a great process and great returns, you will build a very substantial business. And if you don't do that, you won't be around.
How have institutional investors' appetite for funds of funds changed?
Ms. Martino: What we're seeing is that institutional allocators that have large amounts of capital are embracing some type of specialization. ... You'll have a large institution come to you and say, “This is what our portfolio looks like, let's have a discussion about what we're missing and what could be added.” We can go to them, look at their portfolio and say, “This is what we see, if you're leaning this way, if you add this element your portfolio, overall, your portfolio allocation will really be improved and we can provide that solution.” What we're seeing is much more specialization for each large institutional client. It's less likely a large institution will give you $1 billion and tell you to put it in your multistrategy. It's more likely they'll say, “I have this pocket and I'm looking for this,” or, “This is what I have, tell me what I need.” It's one of those two dialogues.
Mr. Schweighauser: It's a customized portfolio solution for the investor.
Ms. Martino: And that is really new.
Are you concerned about strategic partnerships taking assets away from funds of funds?
Ms. Martino: We've always seen it. We have always seen larger groups trying to execute the trading strategy in-house and some (do so) very successfully when they can retain and pay their staff. We've also seen a lot trying to execute that trading strategy and not retaining staff. As soon as their staff knows enough, they're worth more on the outside than in; it's a constant rotation. It has to do a lot with the institution itself, in whether they have the structure to maintain the quality of investment professionals.
Mr. Schweighauser: The key to all that is making sure you don't make an investment mistake, because if you invest in a manager that blows up, however much money you allocated to that manager, have you really saved that much effectively? A 4% allocation to a manager is years and years and years of fees.
Ms. Martino: They really have to look at it that way. n
This article originally appeared in the September 3, 2012 print issue as, "Keeping constant".