Segregated hedge funds pique interest of large investors

Some very large institutional investors are tiptoeing into segregated hedge funds.

Dismayed by managers that last year locked up, gated, froze or otherwise restricted redemptions, institutional investors are actively investigating moves into hedge investment vehicles that guarantee liquidity and investor control over the investment.

John Godden, managing principal of MAG Consultancy, London, said his team is working on moving $63 billion of assets now invested in traditional commingled hedge funds into newly built segregated hedge fund portfolios.

What institutional investors are evaluating are special-purpose hedge fund vehicles in which the assets are managed either in dedicated accounts for a single large client or in a commingled fund with assets segregated by client.

Investors using segregated hedge funds, which are also called managed accounts, control every aspect of the relationship: the selection of the custodian, prime broker, risk management provider, money manager and investment strategy, said Rich Nuzum, president and global business leader of Mercer's New York-based investment management business. Because the investor owns the vehicle, it has the ability to fire the existing manager and hire a new one, he said.

With the segregated commingled hedge fund, investors have no control over the investment or the infrastructure, but they will receive complete holdings transparency, risk reporting and guaranteed liquidity, whether that is weekly, monthly, quarterly or some other time period that suits the liquidity of the underlying assets of the hedge fund.

Some institutions, like the $198.9 billion California Public Employees' Retirement System, Sacramento, might choose to build their own segregated hedge fund portfolios.

One such fund is the $83 billion Teacher Retirement System of Texas, Austin, which is “investigating hedge fund investing via separate accounts, judging the trade-off between the advantages ... and the costs (which include) operational complexity, the cost (legal fees and staff time) to negotiate investment management and counterparty agreements, and the increased back-office costs that have to be absorbed somewhere,” Howard Goldman, spokesman, wrote in an e-mail response to questions.

“We are also investigating the benefits of managed accounts - for instance. greater transparency - without changing the legal structure of our investments,” Mr. Goldman wrote.

Mr. Goldman said TRS staffers are in an information-gathering stage and have talked to separate account platform providers as well as the fund's existing hedge fund managers. No request for information has been issued and a search has not been conducted. Texas Teachers' hedge fund portfolio totals about $3.4 billion.

Other investors rumored to be considering setting up their own portfolios include the $200 billion China Investment Corp., Beijing; the $16 billion Utah Retirement Systems, Salt Lake City; and the C$87.4 billion (US$79.9 billion) Ontario Teachers' Pension Plan, Toronto. CIC officials could not be reached for comment.

Larry Powell, deputy chief investment officer of the Utah fund, did not return a call seeking information. Deborah Allan, Ontario Teachers' spokeswoman, said the fund does not disclose information about its hedge fund portfolio.

There are two options to access segregated commingled hedge funds. One is to create a portfolio using the managed account platforms offered by the likes of Lyxor Asset Management, Paris, and HFR Asset Management LLC, Chicago. Managed account platforms feature multiple hedge funds, more than 100 in Lyxor's case and close to 75 for HFR.

Hedge fund managers offering commingled managed account versions of their flagship investment strategies include firms as large as Tudor Investment Corp., New York.

The other option is to invest in hedge funds of funds that invest only in managed hedge fund accounts. One example: Nestle Capital Advisers SA, manager of the $16 billion defined benefit plan of Nestle SA, Vevey, Switzerland, moved an existing hedge fund mandate to a hedge fund of funds using managed accounts from Gottex Fund Management Holdings Ltd.

MAG's Mr. Godden said that for first four or five months after the market crisis began last year, “people wanted information and to gauge the lay of the land.” Now, he said that has shifted into “writing checks” and “it's all about existing money changing the hedge fund investment infrastructure.

“It's all about taking control. For both hedge funds of funds and institutional investors, it's about choosing all parts of the equation.”

“There really is a lot at stake, a huge prize, for hedge fund managers and managed account providers who win some of these first enormous mandates,” said consultant Richard Tomlinson, CEO of Tomlinson Investment Consulting, London.

Pension funds, endowments and foundations aren't the only investors making a move to segregated hedge funds. Hedge funds-of-funds managers also are switching because liquidity is guaranteed. Using hedge funds that can't put up a gate to stop redemptions will help funds of funds avoid the liquidity mismatch that plagued them in 2008 when their investors asked for redemptions, but the underlying hedge funds had frozen assets.

Mr. Godden said MAG Consulting is working with a number of hedge funds of funds to set up segregated hedge fund programs, most recently with EIM Group, Nyon, Switzerland.

Executives at funds-of-funds manager Lighthouse Investment Partners LLC, Palm Beach Gardens, Fla., spent the past five years developing a managed account hedge fund approach and now offer five strategies, said Kelly Perkins, managing director and co-CIO.

Lighthouse manages about $5 billion in funds of funds, of which about $2 billion is in the managed account structure. Mr. Perkins said he anticipates that between 55% and 60% of the firm's assets will have moved over to the managed account program by the end of the year.

HFR has seen an explosion in its managed account hedge fund platform this year.

Assets managed on HFR's hedge fund platform were $3 billion at the end of 2007, but dropped to $1 billion by Dec. 31, 2008, because of market performance and the return of about $1.5 billion in response to investor redemption requests, Jordan Allen, HFR Asset partner and head of business development, said in an interview.

But investors are “coming back into the hedge funds now and are rewarding us for meeting our liquidity promise,” Mr. Allen said. “After strong flows (during) the past few months and with committed allocations, we expect AUM to surpass $2 billion early in the fourth quarter ... (We) currently are working on several billion dollars of projects for clients. ... Certain larger plan sponsors are considering custom solutions for all or a part of their programs,” and smaller ones have made managed accounts a preferred structure..

Mr. Allen said HFR also is meeting demand from private banks to provide their high-net worth clients with a managed account structure, as well as from funds of funds, both large and small, that want to use the platform for part or all of their hedge fund allocations.

Mr. Allen said there also is a long line of hedge fund managers that want to set up managed accounts on the platform — in many cases, bringing institutional clients with them.

Lyxor's 11-year-old managed account hedge fund platform also has seen very strong flows this year, Nathanael Benzaken, managing director and head of managed account platform development, said. Lyxor was able to meet all redemption requests last year and has seen $3.5 billion of net inflows since early January, mostly from institutional investors. Mr. Benzaken declined to say how much is managed on Lyxor's hedge fund platform.

After nearly six months of work on the “build-it-yourself” hedge fund makeover that CalPERS undertook beginning in April (Pensions & Investments, April 20) what's very clear is that the “strength of using a separate account is really coming out. This is a much better structure for us because it fit CalPERS' needs so much more precisely than a commingled vehicle could,” said Craig Dandurand, a CalPERS' portfolio manager in global equity.

Mr. Dandurand and his boss, Kurt Silberstein, senior portfolio manager, global equities, are the architects of the effort to better align investor and manager interests for the fund's $5.7 billion hedge fund portfolio.

Mr. Dandurand said reaction to separate accounts has been positive from most of CalPERS' 21 direct hedge fund managers, as well as from potential new hires, to the proposal to move to what he calls “a fund of one.”

He wants to have “a multiple number” of hedge funds restructured into separate accounts before the end of the year.