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Hedge Funds

New investments down, but so are redemptions

Institutions took time to upgrade, tweak portfolios

Victoria Vodolazschi said 2017 was all about ‘ugrading and optimizing.’

Institutional investors continued to slow the pace of new hedge fund investments in 2017, while simultaneously reducing redemptions from existing managers.

Combined investment in hedge funds and hedge funds of funds was down about $1.4 billion, to $9.8 billion, or 12.1% below 2016 inflows, showed analysis of the investment activity of asset owners as reported by Pensions & Investments throughout the year.

Hedge fund inflows declined 2.1% in 2017 to $8.7 billion, while investment in funds of funds fell 51.5% to $1.1 billion.

In a near reversal of the prior year's trend, combined redemptions from hedge funds and hedge funds of funds were down 86.7% to $1.4 billion in 2017. In 2016, total redemptions were up 81.6% to $10.3 billion.

"Redemptions seem to have slowed down. The theme this year was more about … upgrading and optimizing the portfolio. This is especially true in the context of market performance and how extended the bull run has been," said Victoria Vodolazschi, senior investment consultant-hedge fund research, based in the New York office of Willis Towers Watson PLC.

"In terms of flows, investors generally were not planning to abandon their allocations and actually planned net increases in 2017," Ms. Vodolazschi added.

P&I's analysis of institutional investor hedge fund activity found general trends including:

  • increases in total hedge fund exposure by large, sophisticated investors;
  • manager upgrades within existing hedge fund portfolios; and
  • more portfolio restructuring to eliminate separate hedge fund allocations and move hedge funds into appropriate asset class portfolios.

The biggest hedge fund investor this year by far was the State of Wisconsin Investment Board, Madison, which accounted for 32% of total hedge fund investments in P&I's analysis.

SWIB, which oversees a total of $115.8 billion in assets, including the Wisconsin Retirement System's $105.5 billion, invested a total of $2.8 billion through 20 transactions with 14 hedge fund managers includingTwo Sigma Investments LLC, D.E. Shaw Investment Management LLC, Marshall Wace LLP and Efficient Capital Management LLC.

The $13.9 billion Maine Public Employees Retirement System, Augusta, was another big player in 2017, awarding $300 million each to two alternative-risk premium hedge funds, as was the $14 billion Los Angeles Water & Power Employees' Retirement Plan which handed Blackstone Alternative Asset Management the year's largest hedge fund-of-funds mandate at $580 million.

Rounding out the list of 2017's five most active hedge fund investors are the $54.1 billion Pennsylvania Public School Employees' Retirement System, Harrisburg, which invested a total of $550 million in two hedge funds; and the $28.6 billion Texas County & District Retirement System, Austin, $495 million to seven hedge funds.

In September, the $23.7 billion City & County of San Francisco Employees' Retirement System increased its allocation to hedge funds to 15% of plan assets from 5%. As part of a quick, one-year boost, the plan is on track to invest an additional $2.5 billion in hedge funds to bring assets to $3.15 billion by the end of October 2018 (Pensions & Investments, Oct. 10).

San Francisco is using a hybrid approach to expanding its hedge fund portfolio: ultimately, 65% of the portfolio will be managed in a customized fund-of-funds portfolio by Blackstone Alternative Asset Management, with the balance directly invested in individual hedge funds.

The plan invested a total of $350 million in five hedge funds in 2017.

Restructuring

Reported redemptions in 2017 generally resulted from portfolio restructuring actions.

The board of trustees of the $49.9 billion Teachers' Retirement System of the State of Illinois, Springfield, for example, approved changes in August to the fund's $3 billion hedge fund portfolio that increased the number of strategy categories to five from three (P&I, Sept. 4).

In October, the board accepted the recommendation of investment staff to redeem $336 million from Bridgewater Associates LP's Pure Alpha hedge fund strategy and $195 million from Tourbillon Capital Partners LP's Global Venture fund because the strategies weren't a good fit in the new portfolio structure (P&I, Oct. 27).

University of Kentucky, Lexington, reduced the allocation of its $1.4 billion endowment to hedged equities to 5% from 14% and consequently redeemed a total of $116 million from three hedge funds in 2017.

But investment staff, led by Chief Investment Officer Todd Shupp, continued to build the endowment's hedge fund portfolio — which has a 20% allocation — by investing an aggregate $150 million in 10 new hedge funds during the year.

The $14.9 billion Orange County Employees' Retirement System, Santa Ana, Calif., joined the growing number of institutional investors eliminating a separate hedge fund bucket in their asset allocations and recategorizing those funds into more appropriate asset classes.

The fund decided to eliminate a 14% dedicated hedge allocation in January and subsequently redeemed a total of $310 million from three hedge funds because "OCERS has viewed hedge funds as a product structure and not simply an asset class per se," said CEO Steven Delaney in a June 1 report to the fund's board.

Mr. Delaney noted hedge funds are found throughout OCERS' portfolio in equity, diversified credit and global tactical asset allocation categories.

No longer separate

Among other institutions that removed hedge funds as a separate asset class are Pennsylvania Public School Employees, the $17.2 billion Illinois State Board of Investment, Chicago; and New Mexico State Investment Council, Santa Fe, which oversees $23 billion in state endowments.

"The movement of hedge funds from their own allocation bucket to other asset classes is a reflection of the maturation of the hedge fund industry," said Christopher Walvoord, partner and global head of hedge fund research, Aon Hewitt Investment Consulting Inc., Chicago, in an email.

"Hedge funds are mostly no longer `two guys and a Bloomberg,' employing exotic trading strategies that nobody has ever heard of. There are still a few of those sorts of managers out there and they are still difficult to classify," Mr. Walvoord said.

Most institutional-quality hedge funds now can be included within a more loosely defined traditional asset allocation framework, Mr. Walvoord added.​