Asset owners up pace of activity with hedge funds

Institutional investors' hedge fund activity rose nearly 17% in 2013, reaching a net total of $10.7 billion.

That activity covers searches for, and hirings of, hedge funds and fund-of-funds managers. A small amount (less than 10%) is attributed to manager terminations.

Net hedge fund activity totaled $9.1 billion for the year ended Dec. 31, 2012, which was a significant drop of 22.9% from the $11.8 billion of net activity in the year ended Dec. 31, 2011.

Pensions & Investments analyzed hedge fund investment, search and termination data from the P&IQ database in the three-year period ended Dec. 31, 2013.

A quick peek at the investment pace in the first quarter of 2014 looks promising, with net hedge fund activity of $3.8 billion, according to P&I's dive into its database.

If the pace continues over the next three quarters — and sources said there's no reason to expect a slowdown — net hedge fund assets could top $15 billion by year-end, the best annual growth in four years.

“There's been a lot of upsizing over the last 12 to 18 months,” with more on the way this year, said Stephen L. Nesbitt, CEO of alternatives consultant Cliffwater LLC, Marina del Rey, Calif.

“There have been some institutional investors making first-time investments in hedge funds during this period, but much of the activity in the past 18 months was in building out portfolios with new hires and by pumping up allocations to existing managers,” Mr. Nesbitt said.

Among the biggest institutional investors that were building and perfecting their hedge fund portfolios during P&I's three-year analysis period were:

nNew Jersey Division of Investment, Trenton, invested a total of $3.6 billion directly in hedge funds for the $76.8 billion New Jersey Pension Fund;

nThree of the five pension funds of the $150 billion New York City Retirement Systems invested a total of $2.6 billion directly in hedge funds;

nOhio Public Employees Retirement System, Columbus, also invested a total of $2.6 billion in hedge funds for its $75 billion defined benefit plan;

nAustin-based Texas County & District Retirement System invested a total of $1.8 billion in hedge funds from the $23 billion fund;

nThe Florida State Board of Administration, Tallahassee, invested a total of $1.7 billion in hedge funds for the $145.1 billion Florida Retirement System, which it manages; and

nEmployees Retirement System of Texas, Austin, invested a total of $1 billion directly into hedge funds in 2012 and 2013, the first step in building the hedge fund portfolio of the $25.3 billion fund, while the $8.3 billion Rhode Island Employees' Retirement System, Providence, invested the same amount in 2011 and 2012.

Institutional hedge fund investing in 2013 totaled $8.9 billion, of which $8.6 billion was invested directly in hedge funds and $327 million into hedge funds of funds, P&I data showed. Total terminations were fairly low at $1.1 billion, $860 million of which came from hedge funds-of-funds managers. Search activity was fairly high at $2.8 billion, with $1.7 billion aimed at hedge funds of funds, while the balance sought direct investment in single/multistrategy hedge funds.

Over the longer term, institutional investment has been healthy on a cumulative basis, especially for allocations into single- and multistrategy hedge funds at the expense of hedge funds of funds.

Total investment for the three-year period came to $32.9 billion, $27.5 billion of which went directly into hedge funds and $5.4 billion into funds of funds.

A high termination rate of $5.5 billion for hedge funds-of-funds investments over the three calendar years was responsible for dropping P&IQ's net activity total for the period. By comparison, terminations of single- and multistrategy hedge fund investments totaled $327 million.

Most terminations by institutional investors were the result of manager upgrades or hedge fund strategy weighting changes, rather than a reduction in the investor's overall allocation to hedge funds, the P&IQ database showed.

For example, of the net $1.3 billion of hedge fund activity over the three-year period for the $124 billion Teacher Retirement System of Texas, Austin, $127 million came from terminations of individual hedge fund investments while $1.4 billion was invested or reinvested in other hedge funds.

Hedge funds-of-funds terminations overall were highest in 2012, with withdrawals reaching a total of $4.5 billion, followed by $860 million in 2013.

The Massachusetts Pension Reserves Investment Management Board, Boston, was responsible for $2.8 billion of the 2012 hedge funds-of-funds terminations after trustees decided to eliminate four hedge funds of funds. Even before closing its hedge funds-of-funds accounts in 2012, PRIM had begun to invest directly in single/multistrategy hedge funds: In 2011, a total of $525 million was invested directly in hedge funds. An additional $200 million was given to other single- and multistrategy hedge funds in 2012 and 2013, P&IQ data showed.

During the same three-year period, the $42.8 billion Teacher Retirement System of the State of Illinois invested a total of $455 million in hedge funds. But termination of one of its two large hedge fund-of-funds investments — $537 million in 2013 — dropped the system's net hedge fund activity to -$82 million, even though investment staff at the Springfield-based defined benefit plan began to put some of those assets back to work by investing a total of $200 million in two multistrategy hedge funds in 2013.

Colorado Fire & Police Pension Association, Greenwood Village, is smaller than many institutional hedge fund investors with $4 billion in assets, but was among the most active hedge fund investors over the three-year period.

The fund terminated three hedge fund-of-funds investments totaling $278 million between 2011 and 2013 and invested a cumulative $666 million directly in 13 single- and multistrategy hedge funds during the same period. n