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November 30, 2015 12:00 AM

Texas Permanent brings internal portfolio to forefront

Christine Williamson
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    Holland Timmins

    The investment staff of the $28.4 billion Texas Permanent School Fund might begin in-house management of a hedge fund-of-funds portfolio sooner than expected.

    Texas State Board of Education, Austin, which oversees investment of the education endowment, approved at a Nov. 20 meeting the recommendation of its finance committee to have investment staff and consultant NEPC LLC develop a proposal for creating an internally managed hedge fund-of-funds portfolio, a webcast of the meeting showed.

    The proposal will be presented to the Committee on School Finance/ Permanent School Fund at its Jan. 28 meeting and, if approved, will move on to the full board for consideration the next day.

    Giving Permanent School Fund staff the go-ahead to start managing an internal hedge fund portfolio was not on the agenda for the finance committee's Nov. 19 meeting.

    As part of a review of the education endowment's $3.1 billion hedge fund portfolio, committee members were asked not to renew Mesirow Advanced Strategies Inc. when its contract for managing a $383 million hedge fund-of-funds portfolio expires Feb. 29, according to a webcast of the committee meeting.

    The discussion around the elimination of Mesirow, one of the school fund's three hedge funds-of-funds managers, led to the internal portfolio proposal.

    Mesirow's role as a manager in the hedge fund portfolio has been in question for more than three years, as part of a prolonged restructuring toward direct investment in hedge funds in an effort to reduce fees, according to meeting webcasts and documents.

    Holland Timmins, the endowment's executive administrator and chief investment officer, proposed at an April 2012 meeting terminating three of five existing hedge funds-of-funds managers — GAM USA, K2 Advisors LLC and Mesirow — and evenly reallocate the aggregate $1 billion of assets to two new hedge funds of funds.

    Mr. Timmins declined to comment for this story.

    The new funds would be co-managed by PSF staff and existing hedge funds-of-funds managers Blackstone Alternative Asset Management and Grosvenor Capital Management LP. Under Mr. Timmins' plan, each firm would become a strategic partner for the co-managed fund and charged with sharing knowledge and training PSF staff to manage the portfolios. BAAM and GCM also would continue to manage their existing hedge fund-of-funds portfolios for the school fund.

    The goal, Mr. Timmins has said in multiple meetings since the restructuring proposal first was floated, is to eventually shift the co-managed accounts to in-house management.

    GAM and K2 were eventually dropped; Mesirow stayed.

    The strategic partnerships began in early 2013 with the establishment of the co-managed funds, called Raven 6 with GCM and Raven 7 with BAAM. (The Permanent School Fund gives each of its hedge funds of funds a Raven name.)

    Mesirow's contract was extended in April 2014 for 18 months, while BAAM and GCM received two-year contract extensions through Aug. 31, 2016.

    The fast-approaching expiration of Mesirow's contract required the finance committee to make a decision soon.

    Mr. Timmins suggested at the Nov. 19 meeting terminating Mesirow and splitting its $383 million of assets between the $355 million Raven 6 fund and $411 million Raven 7 fund. Mr. Timmins told the five-member finance committee that Mesi-row underperformed its benchmark for three quarters and was put on the fund's watchlist, according to the Nov. 19 webcast. He did not provide performance details.

    Mesirow's “performance has not been at a level to justify the fees,” Mr. Timmins said, specifying that PSF paid $2.8 million annually in fees to Mesirow.

    Greg T. Fedorinchik, senior managing director and head of client portfolio management at Mesirow Advanced Strategies, Chicago, declined to comment.

    Internally managed

    Committee members shifted their discussion to setting up a 100% staff-managed hedge fund-of-funds portfolio (Raven 8) with some portion of the assets redeemed from Mesirow.

    Committee member Lawrence A. Allen Jr. said he expected that three external managers would continue to split management of PSF's hedge fund portfolio when the strategic partnerships hit their third anniversary. But he added, “I wanted from the start to see staff operate independently,” and further said “it's time for us to look at when internal managers will completely take over management of the portfolio.”

    “Is staff ready to run a portfolio without joint input?” Thomas Ratliff, a committee member, asked Mr. Timmins.

    “I am completely confident that staff is ready to do this,” Mr. Timmins said.

    During further discussion, finance committee members began to question the logistics of setting up a staff-managed fund, including the option of hiring a specialist hedge fund consultant to advise staff on manager sourcing and selection, the webcast showed.

    Rhett Humphreys, the fund's lead consultant and an NEPC partner, cautioned the committee that an external adviser would to needed to “protect the board's fiduciary” position.

    “I think this issue requires a lot more discussion,” said Kenneth Mercer, a committee member.

    A motion was made to not to renew Mesirow and distribute 50% of the assets evenly between Raven 6 and Raven 7, with the remainder to a staff-managed Raven 8.

    That motion was amended to terminate Mesirow and direct staff to present options for reallocation at the committee's January meeting. The motion failed.

    A third and final motion, which passed, did not address Mesirow. It directed staff and NEPC to bring a proposal to create Raven 8 to the January meeting. n

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