ALTERNATIVES

Michigan State switches to quants as hedge funds drive loss

At Michigan State University, it's out with the old hedge funds and in with the quants.

After posting a 4.3% loss in its last fiscal year, the university's endowment is pulling $100 million from four hedge funds and moving the money into computer-driven funds to diversify the portfolio.

Half the money will go to a fund run by Renaissance Technologies as the school unwinds its investments mostly from long/short hedge funds, said Chief Investment Officer Philip Zecher. Michigan State is switching strategies for part of the allocation, including its first deployment in quantitative funds, rather than abandoning hedge funds.

“It was a very bad year for a lot of hedge funds; it was a particularly bad year for the styles we were invested in,” said Mr. Zecher, who began as the first CIO of the East Lansing-based public school in January. “If hedge funds are there to be a diversifier and help manage volatility as well as produce return for the portfolio, it doesn't make sense to have them all doing the same thing.”

The value of the endowment fell 2.4% to $2.35 billion as of June 30.

Some endowments and pension funds are decreasing allocations to hedge funds because of poor returns and high fees. Berea College is unwinding about $42 million in hedge fund commitments this year from its $1.1 billion endowment, as hedge fund performance contributed to the Kentucky school's investment decline of 1.1%.

Michigan State's 10-year annualized return is 5.5%. The school's investment declines were led by a 9% drop in its hedge fund portfolio, said Mr. Zecher, who has a doctorate in nuclear physics. Switching strategies will provide more diversity in the allocation, rather than putting money in expensive equities or fixed income.

“You've got to put it some place,” said Mr. Zecher.

MSU is unwinding investments from activist fund Marcato Capital Management, Pennant Capital Management, Valinor Management and Wingspan Investment Management, according to the school.

Pennant closed one of its hedge funds last year to boost returns. Wingspan is closing down and returning capital to investors, citing poor performance and market conditions, according to a client letter last week. Its long/short investing strategy focused on leveraged corporate capital structures and targets opportunities across performing, stressed and distressed credit as well as special situation equities.

The fund suspended investors' right to redeem their capital as of Dec. 1, and MSU isn't affected because the school already received its money back, Mr. Zecher said.

Representatives of the four firms declined to comment.

MSU is also paying attention to fees.

The Renaissance Institutional Equity Fund generally charges a 1% management fee and 10% performance fee, the latter about half of the typical industry rate. Investors such as MSU making larger allocations often pay even lower charges.

MSU plans to allocate the second $50 million from the redemptions to other quantitative funds still to be chosen. Mr. Zecher said he puts more value in unique data, more than traditional market data or pattern-recognition algorithms.

“To me, the really big issue these days is what is the data they're looking at,” he said. “How differentiated is the data set that they are able to use in making decisions?”

The school's hedge fund allocation dropped to a quarter of the fund from 29% a year earlier, mostly because of performance.

After hedge funds, its next-largest allocation in the fiscal 2016 year is U.S. equity at 19%, similar to last year's allocation, followed by private investments at 17%, up from 14% the previous year. MSU is also allocating about 14.2% to international equities, down from 13.7% the previous year.