MassPRIM considers more proactive asset allocation

The Massachusetts Pension Reserves Investment Management board decided last week to do its second comprehensive asset allocation review in three years, amid a flurry of moves aimed at leaving the $48.3 billion system better positioned to pursue fast-moving investment opportunities.

At a Feb. 1 meeting, board members also decided to embark on a pilot program to invest money directly with hedge funds, six years after launching a hedge fund-of-funds program that has grown to $3.6 billion.

“The board thinks it's prudent to revisit asset allocation more often and be more proactive in suggesting beneficial changes that will improve the probability of more consistently achieving our actuarial rate of return of 8.25%,” Stanley Mavromates, PRIM's chief investment officer, wrote in an e-mail.

To support that more dynamic process, trustees also approved plans to issue an RFP for a risk management system.

In a telephone interview, Michael Trotsky, a hedge fund veteran who became PRIM's executive director in August, said cutting-edge risk management tools have become “absolutely critical” in making intelligent decisions on asset allocation and rebalancing.

Such tools have become “best practice” in helping staff understand “the portfolio you have on any given day ... and how it could behave” under different economic scenarios, Mr. Trotsky maintained.

Over the past year, a growing number of bulge-bracket public funds, including the $228.5 billion California Public Employees' Retirement System, Sacramento, and the $123 billion Tallahassee-based Florida State Board of Administration, have moved to deploy risk management systems. According to consultants, a much larger proportion of defined benefit plans offered by large corporate sponsors — overseen by risk-focused treasury departments — already have such systems in place.

Mr. Trotsky said the information a risk management system provides will set the stage for other initiatives, such as the board's decision to carve out some of the system's existing hedge fund-of-funds allocation to begin making direct investments in hedge funds.

More frequent reviews of asset allocation will allow PRIM to identify and move into good investment opportunities more quickly, while the risk system “will allow us to quantify the risks inherent” in those opportunities and properly size any new investments, said Mr. Mavromates, in an e-mail.

At its latest meeting, the PRIM board also approved issuing an RFP on Feb. 7 for asset allocation consulting services, with agenda materials noting the need to hire a “stand-alone” provider of asset allocation advice to “take into account the dynamic nature of the current investment landscape.” Hewitt EnnisKnupp, the system's general consultant, currently provides asset allocation advice as part of a package of services.

The Massachusetts state fund isn't alone in looking to fine-tune its asset allocation efforts, investment consultants say.

Following the market's deafening wake-up call in 2008, a growing number of sophisticated investors are moving to review asset allocations more frequently — if not continuously — to “see if the future is evolving the way they thought it would,” noted Terry Dennison, Los Angeles-based U.S. director of consulting with Mercer LLC.

“The days when you set your asset allocation and locked it in a filing cabinet for three years are over,” he said.

The move to dip its toes in direct hedge fund investing is a dramatic shift for MassPRIM. The system is one of only two among the 10 public funds with the largest allocations to hedge funds to remain solely invested in funds of funds, according to materials provided to the PRIM board last week.

According to those materials, the hedge fund allocations of five of the top 10 — Pennsylvania Public School Employees' Retirement System, Virginia Retirement System, the Teacher Retirement System of Texas, the New York State Common Retirement Fund and the Texas County & District Retirement System — are entirely invested directly in hedge funds rather than funds of funds.

In a telephone interview, Mr. Mavromates said PRIM staff and board members have long debated the relative merits of funds of funds vs. direct investments, but the weight of recent experience finally tipped the argument in favor of diversifying the program.

For example, the argument that the extra layer of fees charged by a fund of funds is a price worth paying to “keep you out of trouble” — relying on those firms to weed out problematic hedge funds — took some hits during the recent financial turmoil, when a handful of the more than 200 hedge fund managers in PRIM's program either blew up or got tripped up in some way, said Mr. Mavromates.

Other drawbacks include significant overlap when it comes to the hedge funds tapped by PRIM's fund-of-funds managers, he noted.

Mr. Mavromates said having a person such as Mr. Trotsky with hedge fund experience take the helm at PRIM added an influential voice to the mix of arguments in favor of direct hedge fund investments.

“We're trying to improve performance” and the current fund-of-funds structure didn't provide significant wiggle room, he said.

The pilot program approved by the board calls for issuing an RFP for a direct hedge fund consultant in February, picking a consultant by April and hiring PRIM's first hedge fund managers around October, said Mr. Mavromates.

As its hedge fund program currently stands, PRIM anticipates paying fees of roughly $30 million this year to its five hedge fund-of-funds providers — Arden Asset Management, K2 Advisors, Grosvenor Capital Management, PAAMCO and The Rock Creek Group — which collectively oversee roughly $3.6 billion, or 7.5% of PRIM's total assets.

Mr. Mavromates said the plan is to take roughly $100 million from each of those five managers for the direct investment program. That would amount to about 1% of PRIM's total assets.

PRIM staff expects the direct investment program to lower overall hedge fund fees while opening up access to “top-tier managers” that don't participate in fund-of-funds programs.

According to PRIM materials, shifting that 1%, or $500 million, to direct hedge fund investments could trim the program's fees by $2.1 million. Should the program prove successful, further shifts could follow, said Mr. Mavromates. At 2%, PRIM's savings would come to $5.8 million, expanding to $9.5 million for a 3% shift to direct investments.