Endowment fund maintains its focus
To suggest an overall asset allocation of 25% of an institutional investor's portfolio to hedge funds is enough to send most plan sponsors running for the hills. But the $1bn University of Carolina endowment fund, has done exactly that.
Investment manager, Mark Yusko reasons that the diversification benefits and the higher potential for long terms rates of return can only really be found in this type of investment. In any one short term period of time, many different styles will do well, but what we find is that the best managers tend to gravitate towards this type of structure as they can manage less assets, they can manage their own assets side by side, and they can make more money, they can be compensated better doing what we want them to do which is producing great returns," says Yusko.
Unlike mainstream asset management, he points out. "Standard asset management business is compensated for raising assets, for charging fees on the most amount of assets they can get. They don't really care about performance, they just want to equal the benchmark, they become closet indexers and the standard long only management approach, we think, is not aligned with our interests in the long term."
The fund's asset allocation breaks down to 10% invested in opportunistic equity: "Those would be what most people think of as true hedge funds, the global macro players, the directional players, the long-biased strategies,"; another 10% to absolute return strategies, which covers the more arbitrage-related and market neutral type investments; and16% of the fund's 25% allocation (4% of the total fund) to domestic equities is invested in long-short strategies.
The fund has exposure to the Jaguar Fund through Tiger Management and Maverick in its opportunistic segment, in the long short area it uses Fierstein Partners and the Rapter Fund, which is part of the Tudor Jones organisation and the distressed securities exposure is dealt with through Contrarian Capital Management.
Yusko feels a spread of funds is essential in managing the risk, particularly for first time investors. "There is a good rule of thumb to follow," he says. "The higher the difference between the best manager and the worst manager in an asset class, the more diversified you want to be.
For example, in fixed income, where the best manager and the worst manager may be separated by 50 basis points, you can be very concentrated. In private equity or absolute return, or opportunistic or hedge funds, where the difference between the top manager and the bottom manager may be thousands of basis points, you want to make sure that you are diversified and that you gain exposure to a lot of different segments."
He adds: "To be very, very good, hedge fund managers should have their own specialties, they should not try to be all things to all people."
The manager selection process is based more on individuals - the ones actually running the portfolios - than the institutions themselves. The fund spends an "innordinate" amount of time interviewing managers, and Yusko estimates that he meets with over 300 managers a year in his quest to find the right partners.
Every month it meets with the selected managers, and analyses the exposure profile, where the bets are being placed, whether they are long in certain markets and short in others, whether they are using leverage and if so, how much is being applied. On the transparency issue, he believes daily checks on a hedge fund manager just are not necessary, and if anything it is improper usage of an investor's time. "There is far too much hype about 'I need to see the portfolio every day'. First of all if you are looking at the portfolio every day, you are not utilising your time very well. Because the bulk of the returns don't come from security selection, the bulk of returns come from asset allocation and manager selection."
Yusko has a simple piece of advice for investors looking to invest in a hedge fund for the first time: "Maintain focus on what is actionable," being the key exposures in the fund and the drivers to performance over the long term. "Does it deviate over a certain amount of time and if so you would want to know why. You are looking for the types of bets they are making in the portfolio, but monthly is plenty of frequency.
It really is quarterly that you want the full blown attribution analysis, have the managers tell you why they did what they did."
However, Yusko points out that there is no point venturing into this area if you don't know what you are doing yourself. As the person overall responsible for the fund's investments it is equally as important to have a solid idea of what is expected and what can be achieved as the manager you are outsourcing to, he says. "Making sure that you understand what you expect from the managers is important. Because if you hire a manager to produce 12% a year and he does that and the market goes up 20%, don't fire him, fire yourself.""