Hedge fund portfolio revamps are front and center on CIOs' desks as institutions, especially public pension plans, refine their investment approaches.
The South Carolina Retirement System Investment Commission and the Teachers' Retirement System of the State of Illinois are among the most recent to begin gut rehabs.
Each is splitting a single hedge fund allocation and regrouping hedge fund strategies by whether their returns are more or less correlated to public equity and fixed-income markets.
They are emulating the leading-edge practices of other asset owners, including the $116 billion Teacher Retirement System of Texas, the $8.1 billion Missouri State Employees' Retirement System, the $28.7 billion Public School Retirement System of Missouri and the $3.1 billion Missouri Public Education Employees Retirement System (Pensions & Investments, April 1).
Other institutional investors are following less drastic evolutionary paths in managing their hedge fund portfolios:
- The $24.7 billion Employees Retirement System of Texas is moving some hedge funds in its year-old portfolio into traditional asset class allocations alongside related long-only strategies;
- The $46.1 billion Alaska Permanent Fund Corp. is edging closer to internal hedge fund management by gradually passing to staff the decision-making authority for co-investments with hedge fund managers;
- The $264.9 billion California Public Employees' Retirement System is considering moving its $5.2 billion hedge fund portfolio to a managed account platform, a structure United Parcel Service Inc. chose for an opportunistic hedge fund of funds built and managed internally for its $27 billion U.S. defined benefit plans.
South Carolina and Illinois Teachers' are undertaking much more radical portfolio reconstructions by separating their hedge fund allocations into directional and non-directional portfolios, a move that will enable chief investment officers to tactically shift weightings in response to market conditions.
Directional hedge fund strategies invest long or short, based on the manager's prediction of market trends. They have more beta exposure to stock and bond markets and therefore thrive - or weaken - in response to market conditions.
Non-directional hedge fund strategies don't make market bets and returns generally are not correlated to those of global public markets.
This approach to hedge fund investment allows the institution to capture market beta during good markets and to collect alpha generated by the non-directional portfolio during down markets, said Stephen L. Nesbitt, CEO of Cliffwater LLC, Marina del Rey, Calif.