The Teacher Retirement System of Texas is radically changing how it pays for the alpha produced by the hedge funds in which it invests.
The $133.2 billion Austin-based defined benefit plan is the first to adopt a new fee structure developed by its hedge fund consultant, Albourne Partners Ltd. The objective of the fee formula is to ensure that the investor consistently retains 70% of the gross alpha returns of the hedge funds in its portfolio.
The structure is dubbed “1 or 30” by TRS and Albourne because it guarantees that the investor will always pay a 1% management fee to the hedge fund, regardless of performance, but will never pay more than 30% of the gross alpha provided annually by a hedge fund.
If a hedge fund's alpha generation is higher than the management fee during a given time period, the manager must deduct the one percentage point management fee from the 30% (of gross alpha) performance fee, showed a case study Albourne prepared after working with the TRS investment department over the summer on the fee plan.
TRS investment staff will not discuss the progress of the new fee schedule for the pension fund's $5.6 billion non-directional and $5.2 billion directional hedge fund portfolios at this point in its implementation. There are 22 hedge funds in the directional portfolio and 26 in the non-directional portfolio. There are additional hedge funds within the fund's emerging manager program.
“TRS is always trying to innovate in improving alignment with our external money managers. While we are working with Albourne, the case study is not an exact representation of any particular fee schedule,” said Howard J. Goldman, a TRS spokesman, in an e-mail. He declined further comment.
Albourne Partners' involvement with Texas TRS on the hedge fund fee project was “borne out of a common academic interest in finding a way for an investor to consistently retain a larger percentage of the total return from hedge fund investments,” said Jonathan P. Koerner, partner, portfolio analyst and global head of implementation, based in the firm's Norwalk, Conn., office. Mr. Koerner is the author of the TRS case study.