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San Joaquin County preps hedge fund portfolio
February 01, 2010
The new 7% portfolio is the pension fund's first formal allocation to hedge funds.
By Anastasia Donde
When the San Joaquin County Employees' Retirement Association set out to create its first dedicated hedge fund portfolio, the California pension plan made two unusual decisions: The fund rewrote its asset allocation last June to make room for a 7% allocation of its $1.7 billion portfolio to a global multistrategy hedge fund, and it wound up hiring Arrowhawk Capital Partners, a firm that had just recently been launched.
Both plans are less daring than they seem: San Joaquin invested in a similar multistrategy fund several years ago, albeit on a much smaller scale, about $45 million. And although Arrowhawk only started investing a year and a half ago, it was set up by FrontPoint Partners veteran Michael Litt, who ran San Joaquin's original hedge fund portfolio.
The county terminated FrontPoint when the group was acquired by Morgan Stanley, in October 2006. The new 7% portfolio is the pension fund's first formal allocation to hedge funds.
Litt, meanwhile, left FrontPoint shortly after the acquisition and spent the next two years working on a business plan for Arrowhawk. Since it was set up in Darien, Conn., in June 2008, the new firm has quickly gained hefty commitments from several large institutions, thanks in large part to Litt's skills at maintaining relationships with plan sponsors.
That's why Arrowhawk didn't seem like a start-up to San Joaquin County. "We knew the individual and his expertise and the skill he demonstrated with FrontPoint," says Annette St. Urbain, chief executive of the San Joaquin fund. But besides presenting a familiar face, she says, Arrowhawk was offering more institution-friendly terms and fees than many of its peers were. It was willing to negotiate on issues such as lockups and performance reporting. In addition to getting performance reports on a weekly basis, San Joaquin received a break on fees—it's paying a 1%, as opposed to the standard 2%, management fee and a 20% performance fee over a hurdle rate of one-year Libor. "We thought that he was coming out with an institutionally-friendly multistrategy hedge fund," says Paul Harte, a vice president at Strategic Investment Solutions, the fund's consultant.
To be sure, the San Francisco SIS and the county ran a formal search for a multistrategy manager, scrutinizing such firms as Och-Ziff Capital Management Group, Eton Park Capital Management and Stark Investments. But Harte said that the board's experience with Litt and comfort level from knowing him back in the FrontPoint days sealed the deal.
The strategies Arrowhawk will provide include commodities, special situations, Japan/Asia investments, energy, volatility and global opportunities. St. Urbain says San Joaquin doesn't have the sizable investment staff needed to source and monitor many different managers, so the multistrategy approach is the best way to get immediate and diversified hedge fund exposure.
Moreover, SIS's Harte prefers multistrategy hedge funds to funds of funds because they provide greater transparency and don't entail an extra layer of fees. SIS is a newcomer to advising clients on hedge fund investing. Harte says the firm had held back, waiting for a shakeout in the industry and for better terms for institutional investors, both of which materialized last year. "In the past, we've had trouble justifying the end result and return potential to our clients. We could only see the hedge fund managers themselves doing well, but it was hard to see the clients doing well." However, in recent months, he says, "On a fee basis and transparency basis, there has been some movement away from what has been the case prior to the financial meltdown."
Arrowhawk is exhibit A. Litt, who was previously a co-portfolio manager of FrontPoint's multistrategy hedge fund, set up Arrowhawk together with Robert Dahl, the former head of global health care at the Carlyle Group, and Stephen Wiggins, who was an operating partner at Essex Woodlands Health Ventures.
Arrowhawk launched its first fund in September 2009 with $500 million in institutional capital. Adam Tosh, chief investment officer of the Kentucky Retirement Systems, which placed its first hedge fund investment in Arrowhawk, said the firm has a "considerably different model, where they are trying to align their interests with the interests of pension plans."
Tosh adds that the young firm has been successful in attracting top talent as a result of the shakeout in the industry. They are bringing in people that "were using Goldman's prop desk and Morgan's prop desk and making money for them, and now they are making money for clients like us," he says. The firm has eliminated redemption gates and side pockets for illiquid securities, and clients will be charged a performance fee only if the fund beats one-year Libor. Litt was not available for comment.
Besides San Joaquin and Kentucky, the firm has signed up the Canadian National Railway as an investor in its hedge fund. The railway reportedly also took an ownership stake in the firm. (Arrowhawk has offered minority stakes in the firm to investors as a perk, as well as a way of financing the firm.) A half dozen or so state plans are said to be signing on as clients. Arrowhawk aimed to start out by launching a hedge fund in 2009 and a private equity fund later.
San Joaquin is still in the process of implementing the other elements of its new asset allocation, which it undertook last June. Following an asset study, the fund decided to carve out a 6% allocation to commodities, as well as the 7% global opportunistic strategies, and it also chose to raise global inflation-linked bonds from 3% of the portfolio to 10%. In addition, it raised traditional fixed income to 34% from 32%, while the fund's real estate allocation remains unchanged at 10%. The new allocations are being achieved by reducing the fund's equity portfolio from 55% to 46%.
The projected returns for the multistrategy portfolio are 600 to 800 basis points over Libor per year, with a fairly low volatility, according to Harte. In the long run, St. Urbain says she expects that the hedge fund portfolio could be increased as well as spread out among several additional types of managers and strategies.
The county pension fund has been tinkering with alternative investments on a small scale as part of its portfolio overlays program since 2005. That's when Bridgewater Associates started managing a currency strategy for the county, which it later converted into its Pure Alpha fund. San Joaquin has also invested with FX Concepts in an active currency strategy, which is often referred to as a hedge fund, St. Urbain says. The plan has another overlay strategy with Mount Lucas Management. But the global opportunistic portfolio was the pension fund's first formal allocation to hedge funds.
The multistrat commitment is part of a broadening of asset classes at the county fund. Last year the fund was occupied with getting commodities exposure and shifting a lot of its domestic large-cap equity portfolio to index management. During the first half of this year, St. Urbain says, the fund will be looking at agriculture, timberland and convertibles. And in the second half of the year, St. Urbain says, the fund might revisit its hedge fund investment strategy.