Investors quick to cut managers not performing

Wary investors push redemptions up 82%

Donald Steinbrugge
Agecroft Partners' Donald A. Steinbrugge

The numbers are in: 2016 was a bad year for poor hedge fund performers as institutional investors expressed dissatisfaction by redeeming and redeploying assets with other managers.

Redemptions were up 82% in 2016 to a total of $10.3 billion, compared with $5.7 billion the prior year, showed analysis of the hedge fund and hedge fund-of-funds investment activity of asset owners as reported by Pensions & Investments throughout the year.

Hedge fund redemptions in 2016 totaled $5.4 billion, up 140% from the prior year; asset owners pulled $4.9 billion from hedge funds of funds in the year, an increase of 44%.

Among 2016's biggest defectors:

  • New York City Employees' Retirement System redeemed its entire $1.5 billion hedge fund portfolio of the $51.2 billion defined benefit plan;
  • Illinois State Board of Investment, Chicago, with total assets of $14.6 billion, reduced its hedge fund-of-funds portfolio to a 3% target from 10%, terminating three firms managing a total of $989 million and reducing the allocation of the remaining manager by $237 million to $440 million;
  • New Jersey Division of Investment, which manages the $72.2 billion New Jersey Pension Fund, Trenton, fully redeemed a total of $2.3 billion from 14 hedge funds after more than halving target hedge fund allocation to 6% from 12.5%.

Announced search activity virtually evaporated last year: The combined total for hedge funds and hedge funds of funds was just $52 million — a 99% decline compared with 2015.

The year's biggest move in hedge funds was the outsized $10 billion search and subsequent hires of three hedge funds-of-funds managers by the 204 trillion ($1.91 trillion) Japan Post Bank, Tokyo. Japan Post Bank's hedge funds-of-funds activity in 2016 was factored out of the aggregate search and investment growth comparison because the mandate size was atypical of the year's activity.

Hedge fund changes in 2016
Institutional hedge fund hire, search and redemption activity, in millions.
Activity by year201420152016% change, 2015 - 16% change, 2014 - 16
Total hires$10,979$11,585$11,182-3.5%1.8%
  Hedge fund direct $7,308$8,615$8,9203.5%22.1%
  Hedge funds of funds$3,671$2,970$2,262-23.8%-38.4%
Total searches $1,981$4,116$10,052144.2%407.4%
  Hedge fund direct $497$324$20-93.8%-96.0%
  Hedge funds of funds$1,484$3,792$10,032164.6%576.0%
Total redemptions$1,405$5,686$10,32381.6%634.7%
  Hedge fund direct $1,174$2,237$5,363139.7%356.8%
  Hedge funds of funds$231$3,449$4,96043.8%2047.2%
Activity by quarter1Q2Q3Q4QTotal
Total hires$2,783$2,882$4,072$1,445$11,182
  Hedge fund direct $2,568$2,362$2,570$1,420$8,920
  Hedge funds of funds$215$520$1,502$25$2,262
Total searches $10,035$0$0$0$10,052
  Hedge fund direct $20$0$0$0$20
  Hedge funds of funds$10,015$0$0$17$10,032
Total redemptions$2,341$1,546$4,704$1,732$10,323
  Hedge fund direct $305$1,464$2,160$1,434$5,363
  Hedge funds of funds$2,036$82$2,544$298$4,960
Source: Pensions & Investments

Hedge fund investments, searches and redemptions by institutional investors globally in 2016 were larger in dollar terms than this story represents because many do not share investment activity publicly.

Making changes

Despite the steep rise in P&I's 2016 hedge fund redemption rate, aside from a handful of large, high-profile hedge fund defectors, sources noted most institutional investors kept their hedge fund target dollars in motion in 2016, upgrading to other hedge fund managers with redeployed and new money.

“Net redemptions in 2016 were on the margin. While a few public pension funds acceded to external pressure from politicians, local media or labor unions to exit or cut down hedge fund allocations, most investors with hedge fund investments understand the benefits hedge funds bring to their portfolios,” said Donald A. Steinbrugge, founder and CEO of Agecroft Partners LLC, Richmond, Va., a third-party hedge fund adviser.

Total new investment tracked by P&I was down 3.5% to $11.2 billion — higher than total redemptions in 2016 — with $8.9 billion going into hedge funds and $2.3 billion into hedge fund of funds. With the majority of institutional hedge fund portfolios at or near full target weights, investment activity now is much more focused on manager and strategy changes, said Peter Laurelli, vice president-research at eVestment LLC, who is based in New York.

“With the realization of portfolio shifts to hedge funds (by asset owners) — from 5% to 8%, for example —the build-out phase has slowed,” Mr. Laurelli said. After a net record $325 billion was invested largely by institutions in hedge funds and funds of funds in the six years ended Dec. 31, “the big wave of investment has abated,” he said.

eVestment's year-end hedge fund inflow data was not available as of press time, but Mr. Laurelli said his expectation is the industry as a whole will have experienced “large negative net outflows” in 2016 with “selected managers” still getting inflows.

“The industry theme in 2016 was hedge fund manager rotation with many investors recalibrating their portfolios with new strategies or new managers,” said Mr. Laurelli.

Among the manager shifts institutions are effecting is a move to boost investment in strategies less correlated to traditional asset classes and other hedge funds, such as managed futures, direct lending and reinsurance, Agecroft's Mr. Steinbrugge said.

“A lot of pension funds are using hedge funds to temper the volatility of their overall portfolios which is leading to a shift in hedge fund strategy choices,” Mr. Steinbrugge added.

By way of example, Mr. Steinbrugge noted that even as the New Jersey Division of Investment bowed to external pressure and cut its hedge fund target over the summer of 2016, investment officers continued to invest in new hedge funds.

In early August, New Jersey investment officers allocated up to $1 billion to a separate account managed by BlackRock (BLK) Alternative Advisors, a unit of BlackRock Inc. (BLK) Portfolio managers there are focused on finding risk-mitigation hedge fund strategies (P&I, Aug. 8). In late September, investment officers decided to invest up to $200 million in another diversifying approach, the Aspect Core Diversified Program, a hedge fund managed by Aspect Capital Ltd. that specializes in global currency, equity indexes, fixed income and commodity markets (P&I, Sept. 28).

Observers said other institutions are following the lead of the $25.6 billion Texas County & District Retirement System, Austin, in rehabbing their hedge fund portfolios.

TCDRS was busy in 2016, moving a total of $760 million of full or partial redemptions from four existing hedge fund managers and reallocating a total of $430 million to six other hedge funds in the portfolio (P&I, Dec. 12).

Still seeking managers

The TCDRS hedge fund team continues to seek new managers. In November it placed $150 million in Sound Point Credit Opportunities Fund, managed by Sound Point Capital Management LP. In January, it placed another $50 million in the fund.

Smaller institutions that have gained experience in hedge fund management over the past few years also upgraded their manager and strategy lineups, observers said.

For example, in 2016, Colorado Fire & Police Pension Association, Greenwood Village, redeemed a total of $182 million from six hedge funds and invested $130 million in four new funds for its $4.1 billion pension fund, while officials of the $2.4 billion endowment of Michigan State University, East Lansing, redeemed $100 million from four long/short equity funds to invest in quantitatively managed hedge funds.

A cadre of large pension funds made significant investments in new hedge funds and strategies in 2016, including:

nFlorida State Board of Administration, Tallahassee, which manages the $143.2 billion Florida Retirement System, invested a total of $850 million in six new hedge funds;

nMassachusetts Pension Reserves Investment Management Board, Boston, allocated $850 million to five new hedge funds from the $63.2 billion pension fund;

nState of Wisconsin Investment Board, Madison, which manages the $94.2 billion Wisconsin Retirement System, invested an aggregate $605 million in six new hedge funds.

Despite the 24% drop in hedge fund-of-funds investment in 2016 because of institutional moves to direct investment in hedge funds, the 527 trillion won ($457.7 billion) South Korea National Pension Service, Seoul, opted to allocate $500 million each to funds of funds managed by BlackRock (BLK) and Grosvenor Capital Management LP for its maiden hedge fund foray.

The $24.3 billion Texas Municipal Retirement System, Austin, another first-time hedge fund investor, decided to invest $895 million in 10 individual hedge funds and $90 million with a single hedge fund-of-funds manager. n

This article originally appeared in the January 9, 2017 print issue as, "Investors quick to cut managers not performing".