Teachers' Retirement System of the State of Illinois is taking a do-it-yourself approach when it comes to finding, nurturing and investing in hedge funds that are owned by minorities, women and disabled people.
Unlike other large institutions that rely on a hedge fund-of-funds manager to run their portfolios, the Springfield-based investment staff of the $44.5 billion defined benefit plan taps a wide network of consultants, money managers, third-party marketers and attendance at forums for emerging and minority-, women- and disabled-owned managers to find promising hedge fund managers.
Illinois TRS has an advantage over other pension funds in the form of a well-established, dedicated emerging managers program with a total of $851 million managed by 19 firms, 16 of which meet minority-, women- and disabled-owned criteria. Across all strategies and all company sizes, the pension fund invests a total of $3.6 billion with 36 M/W/DO managers. Only one of those firms, Varadero Capital LP, is a hedge fund manager, with a $101 million allocation that is included within the pension fund's total hedge fund assets of $2.7 billion.
“We have a reputation of being open to talking to new minority- and women-owned firms, so many firms come to talk to us before they've even opened,” said Kenyatta K. Matheny, TRS' senior investment officer-alternatives and emerging managers
“We have a big network, but you really have to be out there, meeting people and you have to actively follow promising managers,” he added.
“The challenge with hedge funds is that many of the talented hedge fund traders who ran a bank prop desk tend to form family offices when they leave to manage between, say $5 million to $50 million of their own money or that of friends and family high-net-worth investors. They aren't interested in marketing or scaling up to handle institutional money.”
The difficulty in finding hedge fund firms with majority ownership by minorities, women or disabled people likely will be ongoing, Mr. Matheny said, noting “the universe will never grow to be as big as the small-cap universe, for example.”
But Mr. Matheny and Kenneth Musick, investment officer-hedge funds, keep tracking and talking to the more promising of these managers, mentoring them to some extent on what they need to do to grow big enough to manage pension fund assets.
One such “young upstart manager” who started talking to TRS investment officials when he opened his firm 3½ years ago is showing signs of wanting to scale up his firm, and Mr. Matheny said he's going to meet the emerging manager firm again soon, possibly to discuss next steps. Because competition for good minority-, women- and disabled-owned hedge fund managers is tough, Mr. Matheny declined to name the manager.
While investment prowess is the first criterion the TRS team considers in evaluating emerging managers, a firm's assets under management can be the next hurdle: Like many other institutions, Illinois TRS' investment can never total more than 20% of a firm's AUM, Mr. Matheny said.
Investing with small hedge fund managers also carries the risk of firms just throwing in the towel and closing shop.
But one bright side of the closure of small minority-, women- and disabled-owned hedge fund managers is that the money is returned and can be recycled for investment in the next generation of promising firms, Mr. Matheny said. n