By Anastasia Donde
For pension funds looking to shake up their alternative investment portfolios, ditching funds of funds and going direct seems to be the de facto move. But not so for the New Mexico Educational Retirement Board, which says it is instead taking a smarter approach to investing in funds of funds.
The $8.3 billion New Mexico pension is revamping its funds-of-funds allocations, having decided to hire specialized managers that focus on specific strategies instead of investing with a variety of diversified funds. The impetus for the changes? Like many pensions, New Mexico ERB had put money into funds of funds that shut down after 2008.
One such fund was Austin Capital Management, which had invested in the Madoff Ponzi scheme, as the fund of fund's investors discovered in 2009.
New Mexico ERB had also invested in Topiary Fund Management, Deutsche Bank's former funds-of-funds division, which also shut down in 2009 after suffering steep redemptions and a decline in assets. After redeeming from Austin and Topiary, New Mexico fell below its target for absolute return strategies and needed to make new investments.
That's when the pension decided to make some changes. Steve Neel, the pension's deputy chief investment officer, says the system conducted a review of its absolute return portfolio in January and found some blank spots.
"We'd taken a step back and looked at where our exposures were and where we had holes, and we looked at various managers that could fit there," says Neel. "We're looking at more focused managers as opposed to multistrategy. That was a cognizant decision."
New Mexico ERB invests 30% of its portfolio in alternatives, of which about 10% is invested in absolute return strategies. The rest is divvied up among real estate, private equity and real assets. The pension is taking the money it pulled from Austin and Topiary and putting it into more specialized funds of funds.
One example is GAM. After a strategy review, the pension's staff discovered that it had little exposure to commodity trading advisers or global macro strategies and decided this would be a worthwhile area to pursue, given that these strategies show little correlation to stocks, bonds or even the hedge fund indices, Neel says. New Mexico ERB invested $150 million with GAM in one of its trading funds that focuses on CTA and global macro strategies on August 1. "It's an area where we had little or no coverage in the past," says Neel.
New Mexico's next tactical move in hedge funds will be to fill out its long/short equity exposure. The investment staff is evaluating five to seven long-short funds of funds, though Neel declines to name who is on that short list. The pension will send due diligence questionnaires to the firms and will select one by this fall. Neel expects the manager will handle between $100 million and $150 million.
New Mexico ERB began pulling out of Austin Capital and Topiary last year. Austin shut down in May last year, following overwhelming redemption requests from clients given the Madoff exposure, and the fund of funds is still winding down. The pension had opted to redeem earlier in 2009, having learned of the manager's exposure to Madoff. New Mexico ERB had originally invested about $150 million with Austin and still had about $42 million tied up with the firm through the end of March. The pension had invested about $100 million with Topiary and still has about $18 million left in the manager.
While New Mexico is redeeming its money from these managers, it's still earning some incremental returns on the small amounts of money it has left with them. Austin Capital gained 7.4% for the pension's fiscal year ending in June, and Topiary, which is still winding down, returned 11.3% for the fiscal year.
Neel says that after the pension learned it was exposed to Madoff via Austin, it focused more on the operational aspect of due diligence. He adds that when New Mexico ERB first invested in Austin in 2006, the pension had just started investing in absolute return funds. He says the staff is better versed in this area now.
"We have much more of a critical eye on operational due diligence; we do on-site visits and kick the tires much more significantly," Neel says.
In addition to fine-tuning its due diligence process, the fund's staff and its consultant, NEPC, are making sure the pension has more control over its exposures and is invested in lucrative hedge fund strategies.
New Mexico's absolute return portfolio is up 2.5% for the year to date and returned 14.4% for its fiscal year ending in June. The hedge fund portfolio was down 19.9% for the previous fiscal year.
When selecting fund-of-funds managers, the pension's investment staff and representatives from NEPC start with on-site visits with candidates. From there, the pension drafts a short list of managers to which the fund will issue a formal request for a proposal and a due diligence questionnaire. That list is then further scrutinized and shortened to a few names that can be brought before the investment committee, and later the full board, for interviews.
The board then makes the final decision on hiring managers after assessing each candidate's performance, track record, operations and risk management.
Neel says the pension picked GAM for the macro and CTA mandate because of its strength and tenure in those strategies and in the fund-of-funds industry in general.
"They have a proven track record of providing alpha," he explains. GAM's fund has historically outperformed most macro indices, the CTA team at GAM is large and the firm has a sizable exposure to European strategies, whereas its competitors are more focused on the United States, says Neel.
GAM's trading fund was down by 0.70% for the year through July and gained 6.53% in 2009. GAM runs a fund of funds consisting of 35 managers across a range of CTA and global macro strategies with significant international exposure.
The plan's existing fund-of-funds managers are running more diversified books. Gottex Fund Management handles about $150 million in a fund of funds that is concentrated in arbitrage and relative value strategies. Gottex's Market Neutral fund returned 2% year to date ending June 30, while its Market Neutral Plus fund gained 2.8%4.1. Benchmark Plus, another fund-of-funds manager, handles the most diversified portfolio, which focuses on smaller managers. Benchmark Plus returned 3.6% for the year to date ending June 30.
Other pensions in the state, including the New Mexico State Investment Council and the New Mexico Public Employees Retirement Association, have been investing in single-manager hedge funds for some time, and several more U.S. pension funds are planning to start investing directly.
New Mexico ERB is sticking with funds of funds for now, but it may go direct in the future. "We're toying with the idea of moving to a core-satellite approach but further down the road," Neel says, referring to a common new strategy of tapping a small core of diversified funds of funds while pursuing single-manager hedge funds for niche strategies. AR