Illinois Teachers fund embraces directness

The Teachers' Retirement System of the State of Illinois, Springfield, is drastically restructuring its $2 billion hedge fund portfolio in a move to all direct investments within the next two to three years.

The changes are the brainchild of Kenneth Musick, absolute-return investment officer, who joined the $39.6 billion fund in October and wasted little time in reconstructing the hedge fund program.

More staff will be needed, Mr. Musick told trustees at May 22-23 investment committee meeting. He didn't provide any details.

First on the tap are searches for a hedge fund consultant and a hedge fund risk management provider.

The searches likely will be posted on the pension fund's website (http://trs.illinois.gov) within two weeks, R. Stanley Rupnik, chief investment officer, said in an interview. Finalists likely will be interviewed at the board's Oct. 23-25 meeting.

The consultant will help staff select single- and multistrategy hedge funds for direct investment. And a risk management system is essential for providing investment performance, position-level transparency and other operational controls, Mr. Musick said.

One of the two hedge funds-of-funds managers — K2 Advisors LLC, which manages $520 million, and Grosvenor Capital Management LP, with $438 million — will be terminated. The remaining firm will assume management of the combined portfolio with a new assignment: Concentrate the hedge fund-of-funds lineup to 20 underlying hedge funds from 60 funds.

Both funds-of-funds managers have been asked to rebid, and the surviving manager is likely to be chosen at the board's Aug. 14-16 meeting, Mr. Musick said.

The pension fund will increase direct investments in hedge funds to 10 from five. Four to six new hedge fund managers will be presented to the board for approval over the next six months, Mr. Musick said.

TRS' current investments in single- and multistrategy hedge funds will be retained: Blue Mountain Capital Management LLC, $230 million; Bridgewater Associates LP, $304 million; Carlson Capital LP, $140 million; Claren Road Asset Management LLC, $214 million; and Pine River Capital Management LP, $189 million.

These changes will be slotted into a new portfolio construction that reorganizes the current 22 hedge fund strategy categories into three new ones: convergent, or differentiated strategies that have correlated performance during times of market stress; convex, or trading strategies that provide positive performance during market downturns; and opportunistic, or strategies that don't fit into either of the other two categories.

Illinois Teachers' trustees also made a wide range of investment decisions during their spring meeting. They preapproved UBS Securities, CP Cogent Securities and Park Hill Group as private equity and real estate secondary market advisers.

Jerry Quandt, investment officer, said the pension fund needs to be able to sell “legacy assets” within the $4.4 billion private equity and $4.6 billion real estate portfolios, “limited partnerships we don't want to be invested in any more.”

The advisers might also assist TRS investment staff in purchasing suitable private equity partnerships on the secondary market, Mr. Quandt told trustees at the investment committee meeting.

Trustees rehired Buck Consultants as the pension fund's actuarial consultant for a three-year contract beginning July 1. Gabriel Roeder Smith was the other finalist.

The board also approved alternative investment commitments totaling $330 million:

• Black River Agriculture Fund II, $75 million in real assets;


• GI Partners Fund IV, $75 million in private equity;


• Oaktree Real Estate Opportunities Fund VI, $75 million in private equity;


• NXT Capital Senior Loan Fund II, $40 million in fixed income;


• Great Point Partners Fund II, up to $35 million in private equity and TRS' emerging managers program; and


• Maranon Senior Credit Fund II, $30 million, in fixed income and part of the emerging managers program.

J.P. Morgan Asset Management's assets managed in active U.S. large-cap growth equity will be bumped up to 5% of the domestic equity portfolio or $465 million, from 3%.

In addition to keeping GMO on its watchlist for underperformance of a $695 million active emerging markets equity portfolio, TRS also reduced GMO's allocation to 5.5% from 9% of TRS' $8.3 billion international equity portfolio. “We learned a lot” from an as-yet uncompleted active emerging markets equity search, Greg Turk, director of investments, told trustees, noting that staffers are mulling GMO's 70% weighting to value stocks and 30% to momentum stocks. GMO is competing in the search. “Emerging markets represent 30% of the international equity portfolio, so it's an important allocation,” Mr. Turk said.

Trustees also approved a staff recommendation to lower The Boston Co. Asset Management's active U.S. growth smidcap equity allocation to 2% from 3% of the $9.3 billion domestic equity portfolio or to $186 million in current dollars. Boston Co. was also added to the TRS watchlist for organizational changes. The reason: the pending departure of co-portfolio manager Randy Watts at the end of the year, Mr. Turk said. Co-portfolio manager Todd Wakefield has assumed leadership, but several analysts also left the growth smidcap equity team, Mr. Turk said. Staff and consultant R.V. Kuhns & Associates Inc. will reassess the firm's situation during an annual review over the summer.

Trustees also ratified hiring Northern Trust Global Investments to manage $300 million in a passive emerging markets equity strategy. NTGI already managed $2 billion in passive core international equity.

The staff also awarded Taplin Canida & Habacht $175 million to manage in a customized floating-rate cash strategy.

Funding for all hires came from cash, passive/enhanced index funds or rebalancing.

Trustees also ratified staff's terminations of Frontier Capital Management from a $139 million active U.S. small-cap growth equity strategy and Trilogy Global Advisors from a $400 million active international growth equity portfolio. Both firms were on TRS' watchlist.

Mr. Turk told trustees that both terminations were made for performance reasons.

Calls seeking comment about the terminations were not returned by Stephen M. Knightly, president of Frontier, and William Sterling, Trilogy Global's CEO and chief investment officer.