UVIMCO cuts its hedge fund target, but dollar allocation stays the same

CHARLOTTESVILLE, Va. — The University of Virginia Investment Management Co., an institutional leader in hedge fund investment, is cutting its target allocation to the investment vehicles to 45% from 57.5%. But it might do so without taking a dime away from its current hedge fund allocation.

UVIMCO, which oversees the investment of endowment and operating funds for the University of Virginia, Charlottesville, might adopt portable alpha strategies that will enable the fund to maintain its high hedge fund allocation, but will shift some of the market exposure to equity strategies, said Christopher Brightman, UVIMCO's chief executive officer. UVIMCO oversees $2.6 billion of the university's $3.1 billion in endowment assets. All of the assets are externally managed.

The changes are a result of UVIMCO's first formal use of a risk budget. The overall goal is to raise the manager's target risk level to a 9% standard deviation from about 5% to 6% previously. Mr. Brightman expects to hike the target risk level by allocating 10% of assets to non-U.S. developed markets, where the fund has been absent for the past three years, and by increasing leverage in its hedge funds.

UVIMCO also has reduced its private equity target to 15% from 19.5%, reflecting its inability to reach the previous target. Real assets, comprising real estate and natural resources, gradually will rise to 5% from 3%, while fixed income will increase to 10% from 5%, including a new 2% allocation of total assets to high-yield bonds.

The change in the policy asset mix doesn't necessarily mean the endowment fund will yank 12.5% of assets — some $330 million — from its hedge fund managers, or that it will hire a bunch of international equity managers, "I don't expect our allocation to hedge funds to decline," Mr. Brightman said.

Instead, Mr. Brightman might turn to portable alpha strategies. This increasingly popular form of financial engineering allows an institutional investor to seek the best money managers, regardless of which asset classes they manage. The fund official can short the managers' market exposure, or beta, using derivatives or swaps and port the remaining alpha onto another asset class.

In this case, UVIMCO could take a combination of hedge fund managers, short their market exposures, and move their alpha to international equities, Mr. Brightman explained. This way, UVIMCO would not disturb its underlying manager structure while establishing a developed-market exposure.

However, some change in UVIMCO's hedge fund lineup is likely. While long-short equity managers comprise 80% of the manager's current hedge fund roster, UVIMCO is considering greater diversification of styles. Under the new policy asset mix, equity long-short will comprise 25% of total assets, while target allocations of 4% each will be given to equity market-neutral, fixed-income arbitrage, global macro, event-driven and distressed managers.

Mr. Brightman emphasized that fund officials will take a very bottom-up approach in picking hedge funds, and will not be looking to fill style boxes. He declined to reveal any of the endowment's money managers.

The change in the policy asset mix marks a desire to take on more risk, and to reduce the fund's reliance on long-short equity managers.

"During the very late 1990s, the board drastically reduced its long-standing, very high allocation to public equities and moved the great majority of that money into hedge funds," said Mr. Brightman said. The endowment fund had invested 75% of assets in public equities in the early 1990s.

The late '90s shift into hedge funds reflected a belief that a stock-market bubble was under way, he said. Another concern was that "many of the most talented investment management professionals were migrating away from traditional business models to hedge-fund business models. The board and staff wanted the assets managed by the most talented (managers) in the world," Mr. Brightman said.

"Now, the most obvious thing is that the equity market crash is behind us. We've decided that there are opportunities in a more varied set of managers than such a high concentration in one style of management," he added.

Mr. Brightman said he plans to conduct a thorough analysis of UVIMCO's managers, but will not establish separate alpha and beta portfolios, as some funds are doing. Instead, "the vast majority of" managers will have some combination of alpha and beta, he said.

The trick is to separate the two in the analysis. "We plan to analyze the market exposure, or beta, in all of our investment managers, and separately estimate and measure the alpha exposure in all of our managers," he said. The goal will be to maximize alpha returns while keeping the fund's total beta exposure at the level set in the new policy, he said.

"We want better returns at the same risk level," he said.

To accomplish that, UVIMCO will use leverage and derivatives, both directly and within funds, according to its policy statement. "The most direct form of leverage is borrowing, but many other strategies, structures, funds and derivatives securities produce similar results and therefore imply leverage," the statement reads.

UVIMCO officials also are studying whether to create internal capabilities to trade derivatives to adjust the total fund's market exposure, Mr. Brightman said. However, a number of managers have the ability to crank up or down the alpha or beta levels in the portfolio, he noted.

"By using these managers and their flexible strategies, we can achieve the results of separately managing the alpha and the beta in the portfolio even without the ability to execute a beta overlay directly," he said.