Increases in U.S. and European merger activity and the number of debt defaults this year have created more opportunities for event-driven hedge funds -- and pension funds and institutional investors are showing strong interest.
Event-driven hedge funds returns were up 19.33% for the year ended Sept. 30, according to figures from The Hennessey Group, New York, vs. the 5.37% Standard & Poor's 500 index return. In 1998, event-driven funds were up only 2.64%, but in 1990 through 1998 they averaged 17.69% annually.
Mark Yusko, chief investment officer for the $800 million endowment of the University of North Carolina, Chapel Hill, is a fan of event-driven funds because he thinks the people running them are smarter and work harder than those running other types of hedge funds.
"I'm a big fan of skill-based managers," he said. "With event-driven funds there's no short cut (to finding investments). You have to do the work, cut into the balance sheet and do the due diligence."
About 11% of UNC's endowment is invested in hedge funds, split between event-driven funds -- including distressed securities -- and relative-value funds.
Edwin Morgens, a founder and chairman of Morgens, Waterfall, Vintiadis & Co., New York, which runs several distressed-debt funds, agrees that a lot of hard work is involved in picking investments.
"The brains-to-dollars ratio is quite high," he said. "It takes a lot of brainpower (to do these deals)."
For example, he said, if the firm is looking at a deal in a foreign country, an official has to go there personally to check out the company.
The opportunities in the distressed-debt area are enormous, he said. Through Sept. 30, defaults had occurred on $19.3 billion of publicly traded debt, already outpacing the 1991 record of defaults on $18.6 billion.
"It's an extremely good time to be a buyer," he said.
The firm is seeking funds for its Restart 6 fund and expects to have $100 million committed at its first closing in January. The fund is expected to eventually close with about $300 million, Mr. Morgens said.
Morgens has about $625 million in its distressed debt funds.
The $4 billion pension fund of Tenneco Inc., Greenwich, Conn., is an investor in Morgens' distressed-debt funds.
(As of Nov. 5, Tenneco was split into two companies, Pactive Corp., a packaging company, and Tenneco Automotive Inc., which will make automotive parts. Both companies will be based in Lake Forest, Ill. However, the pension fund will not be split up; it will be run by Pactive for the employees of both companies, according to Robert Blakely, who was chief financial officer of Tenneco and left the company on the day it was split up.)
Mr. Blakely, who was also chairman of the investment committee that oversaw the pension fund, called Mr. Morgens a little more than two years ago and asked him to register his fund with the Securities and Exchange Commission so Tenneco's pension fund could invest in it.
"For an ERISA fund it's easy to find lots of classic equity and fixed-income investments," he said. "It's harder to find alternative investments, and we decided we didn't want to be in real estate or LBO funds."
The pension fund decided it wanted to follow the path of Ithaca, N.Y.-based Cornell University's $2.6 billion endowment, which is also an investor in Morgens' funds, Mr. Blakely said.
(James Clark, associate treasurer-investments at Cornell, refused to comment on the endowments' hedge fund investments, including the Morgens investment.)
"The returns are above what you get in fixed income," said Mr. Blakely. Tenneco invested about $25 million in Morgens' fund about two years ago and is satisfied with the returns it has received.
Morgens' funds had a 4.5% return for the year ended Sept. 30. The funds lost 15.49% in 1998, when many hedge funds suffered, but has an average annual 11.89% return for the 10-year period through the end of 1998.
Vassar takes part
Jay Yoder, chief investment officer for Vassar College's $570 million endowment, is also a fan of event-driven hedge funds.
"They smooth returns and reduce the volatility of the portfolio," he said. "The returns are not correlated with traditional investments, including stocks."
Investments in distressed debt make up the largest portion of Vassar's event-driven portfolio. But, he said, there are many opportunities in the event-driven fund area, including a legal event that would affect the returns of a company that is involved in litigation -- Microsoft's legal fight with the U.S. government is one well-known example -- and closed-end fund arbitrage.
"Our main focus is distressed debt, but we do a few other things as well," he said.
Jason Huemer, a partner with York Capital Management, New York, reported that his firm's year-to-date return as of Sept. 30 was just above 16%. The firm invests across the event-driven universe, in merger arbitrage, distressed debt and special situations, and has more than $500 million under management.
"Historically, we perform well when the S&P index does not perform well," he said. "I think that's true across the event-driven (investment) world.
"There is more and more interest by the pension fund community in these funds."
He pointed out that for the past few years, pension funds have been investing heavily in private equity, including venture capital.
"If you take a look at how that area developed, it appears that the hedge fund industry is having a similar growth curve," he said.
The news that the $160 billion California Public Employees' Retirement System was investing in hedge funds, he said, "was a watershed event. CalPERS' announcement gives investors a level of comfort that this was an institutional quality investment."
However, Patricia Macht, a spokeswoman for CalPERS, said the pension fund is investing in part private and part public "hybrid" funds and does not plan to make huge investments in hedge funds. The firm may make investments in hedge funds "opportunistically," she said, but news stories reporting the fund would make large investments in hedge funds were inaccurate.
The $21 billion Commonfund Group, Wilton, Conn., has been investing in event-driven hedge funds since 1994, according to Jeff Landle, managing director, alternative investments.
"We employ them in our lower risk fund structure. There is an attractiveness because of their generally reduced correlation to equities," he said.
John Bader, a partner with Halcyon/Alan B. Slifka Management Co. LLC, said, "There's a growing acceptance by pension funds in the asset class as an investment."
Pension funds, he added, "want institutionalized firms with institutionalized processes," which he said Halcyon, with more than $1 billion under management, uses.
Halcyon's investments include merger arbitrage, distressed debt and special situations. Europe has been a particularly fertile area for investments over the past year, he said.
Halcyon had a 14.14% return over the first nine months of 1999. It was also up 15% in 1998, when most other event-driven hedge funds had poor returns.