A State Pension Plan Hedge Fund Mandate - It Takes a While

American investing institutions are the dominant source of capital for the hedge fund industry. It is important to understand how and why they act. The Wyoming Retirement System just announced who would be managing its assets for its first hedge fund allocations. The winners of the mandates are not surprising, but here the focus is on the process that resulted in those winners. A search of the internet for references to the Wyoming Retirement System and hedge funds allows you to put together a chronology from the headlines:

June 2001: "Wyoming Studies Alts"

…The Wyoming pension fund is planning to make a decision about whether to push into alternatives investments such as real estate, private equity and hedge funds. ..Plan officials are working with the fund's consultant Buck Consultants.

August 2004: "Wyoming Puts Hedge Funds on the Back Burner"

…Wyoming has been slowly continuing its hedge fund education ... and would likely consider a fund of funds to temper its risk…

November 2004: "Wyoming to Decide on Hedge Funds Next Year"

…The plan has been mulling an allocation to hedge funds for more than a year…Mellon Consultants is advising…

March 2005: "Wyoming Appoints PIMCO for Absolute Return Mandate"

March 2009: "Trent May Joins Wyoming as First CIO"

…Trent May joins from hedge fund Deer Creek Capital Partners…

August 2009: "Wyoming Taps NEPC as General Consultant"

November 2009: "Wyoming Considers Its First Hedge Fund Investment"

… The change of tack has much to do with the retention of New England Pension Consulting as an advisor by the retirement system in September…

April 2010: "Wyoming Board Gives Permission to Invest in Hedge Funds"

August 2010: "Wyoming Puts out Combined Search"

…Wyoming Retirement System, is searching for multiple managers to run up to $560 million combined in a global tactical asset allocation strategy and a global macro hedge fund strategy… The system plans to hire three to six managers for a global macro hedge fund mandate, which will make up 30% of the $560 million. Trent May said the number of managers hired for both investments is dependent on RFP responses. The two investments will make up about 10% of the entire portfolio.

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As a responsible and accountable public body the Wyoming Retirement System has to make available documentation for its processes and meetings. The source document for the combined search is well put together, and can been seen here.


The selection process uses the Due Diligence Questionnaire (DDQ) as the key screening document. The risk/ return data should reduce the list of all applicants down to long list. And the DDQ can be used to get to a short list that can be evaluated for full-blown due diligence. New England Pension Consultants have put together some great questions to ask in addition to those in the standard questionnaire. They are in the full document for which the link has been given. In this case NEPC have used the Greenwich Roundtable Global Macro DDQ as the starting point – and very good that is too, as are all the Roundtable Guides. The following are extracts from the request for proposals for the hedge fund mandate:

Global Macro Hedge Fund Managers

To be considered for appointment as a global macro hedge fund manager pursuant to this proposal, investment management firms shall have not less than:

1. $250 million of verifiable total firm assets under management
2. Two (2) years verifiable Global Macro investment experience

 

List of Requested Documents & Data

DDQ

Pitchbook

Historical Monthly Returns & Monthly AuM in Excel

Organizational Chart

PPM

Biographies of Principles and Investment Professionals

Latest Monthly/Quarterly/Annual Letter & Risk Reports

EVALUATION AND SELECTION

Proposals will be evaluated and subsequent judgments made taking into account the following criteria:

• Performance – Return and volatility expectations. While each manager will be evaluated on its relative investment merits the aggregate GTAA allocation will be measured against a 60% MSCI ACWI / 40% Barclays U.S. Aggregate benchmark.

• Expertise – (a) Similar work performed for other institutions, with references of such funds to be specified in the proposal; (b) Assets under management; and (c) Investment experience broadly defined and experience in global tactical investments specifically.
  
  
• Key Personnel – Personnel to be assigned to this account, including key professionals, applicable portfolio managers, back-up and other staff assistance, and education and experience of all such key personnel.
  
  
• Fees – Reasonableness and competitiveness of fees.

• RFP Proposal – Clarity and responsiveness to requirements as requested in the RFP.

• Philosophy and Style - the extent to which the proposed philosophy and style best complement existing philosophies and styles and meet the requirements and expectations as presented in this RFP.
  
  
  Selection Process:
  
• All RFP's will be reviewed with respect to the evaluation of the proposal by the Wyoming Retirement System's staff and the Board's investment consulting firm, New England Pension Consultants (NEPC). WRS' Chief Investment Officer, with the approval of the Executive Director, and in consultation with NEPC will be the sole judge with respect to the final selection of the firm(s) hired.
  
  
• Finalists will be notified of the results of the RFP selection process as soon as possible following selection; due diligence visits may be arranged with firms who make the finalist list.
  
  

The result of the search is that Moore Capital Management, Graham Capital Management, Brevan Howard, Caxton Associates and BlueCrest Capital Management have each been given $30m of capital, and a further global macro manager is expected to be appointed. Although the RFP gives threshold criteria of at least $250m in AUM and a minimum of a 2 year track record, which give scope for dozens of firms to qualify, it is hard to argue against the selections made. Amongst the five named there is a good variety of style, bias by asset class, and differences in pattern of return. It has taken a while in this particular case, but it is easy to see, given the process, why the hedge fund industry continues to get more concentrated as it is driven by American institutional investor flows.

Europe’s Big Hedge Funds Not Growing from Net Subscriptions

Every six months the UK's Financial Services Authority conducts the Hedge Fund Survey (HFS) and the Hedge Fund as Counterparty Survey (HFACS) to help the regulator analyse the systemic risk posed by hedge funds. The latest surveys were conducted in September/October 2010, and the results were released yesterday.


The surveys give invaluable insights into the state of the European hedge fund industry. The HFS asks selected FSA-authorised investment managers about the hedge fund assets they manage and the large funds (equal to or greater than US$500 million in AUM) for which they undertake management activities. So the survey is top-down by size, but given the concentrated nature of the industry the survey well reflects the European industry as a whole, the UK regulator overseeing funds controlling around 80% of the European end of the industry.


The September 2010 survey covered about 50 investment managers with just over 100 funds qualifying by size. Together these firms reported approximately US$380 billion of hedge fund assets under management. The FSA estimate that the HFS captures approximately 20% of global hedge fund industry assets under management. Major American hedge fund groups with a London office, such as Highbridge and Moore Capital Management, will be in this survey.



There are a number of interesting and significant results in the survey:

 
1. Net subscriptions for large funds were negative in the six months to September 2010.

Aggregate assets under management increased in the survey period due to positive performance. But the picture of subscriptions and redemptions was more mixed. Approximately one half of large funds in the September 2010 survey reported a decline in AUM driven by negative net subscriptions (Chart 1). In aggregate, negative net subscriptions reduced assets under management by 0.8% versus the aggregate assets at the start of the survey period.

Chart 1. Distribution of Change in Large Hedge Fund AUM for the 6 months to end September 2010

source: FSA

2. There was little change of the size of hedge fund assets in side pockets

"Assets under special arrangements due to their illiquid nature, such as in 'sidepockets', remained largely unchanged at 11% of aggregate NAV, suggesting no improvement in the quality of these assets," according to the FSA.

 

3. Large funds in Europe have recovered to their high-water mark

Assets below their high-water mark have declined to less than 5% of total surveyed assets, down from 43% reported in the October 2009 survey. So the profitability of European hedge fund management companies should be much improved in 2011.

4. Hedge fund managers in aggregate have been able to agree a lengthening of their term of credit.

The term of financing has been 'pushed out' in aggregate, with a reduction in short-term financing of between 5 and 30 days and an increase in financing terms of 31 to 180 days (Chart 2). This gives more potential for stability within the portfolios, as positions will not have to be reduced because of a shortage of short term finance, as can happen when short term financing is rolled over on a frequent basis. The leverage providers are overwhelmingly the prime brokers.

Chart 2. Financing Term – Percent of financing by days

source: FSA

5. The average excess collateral held by prime brokers is as at the low end of the 5 year range.

The Hedge Fund as Counterparty Survey suggests that the average excess collateral is currently around 90% of the base margin required (Chart 3).The FSA notes that there have been developments in hedge funds' cash management which may impact the movement of collateral, such as an increased use of custody accounts for excess collateral.

Chart 3. Average Excess Collateral Held by Prime Brokers – Collateral as a percent of base margin

source: FSA

6. Commodity futures positions of hedge funds has become an issue of note to regulators, and should be one to investors and the funds' managers.

According to the FSA the footprint of surveyed hedge funds within markets is generally small when measured by the value of their holdings, suggesting that in aggregate they do not have a major presence in most markets. However, the regulator for most of Europe's hedge funds states that there are potential exceptions in convertible bonds, interest rate and commodity derivatives. Hedge funds have been nearly 5% of the open interest in commodity markets in the last year. These positions might be held for reasons of medium term value, but for most hedge funds the holdings are governed by momentum-based tactics. So the exit may become very crowded in some of the smaller commodity markets where hedge funds are relatively new, if large, market participants.

   
7. The relative decline of funds of hedge funds within the industry is illustrated again

FSA survey data shows (Chart 4) that the large hedge fund groups have well diversified sources of capital for their larger funds. A surprise in this analysis is the low percentage of capital of large hedge funds routed via funds of hedge funds – only 28% (or less) of capital of large hedge funds was contributed by funds of funds (and other funds). There may be some under-estimate of total holdings of endowments and pension plans in this data, as these institutions and HNWIs may have hedge fund exposure via FoFs as well as through direct holdings. However it is difficult to refute that funds of funds are contributing much less of the capital of large hedge funds in 2010.

Chart 4. Sources of Hedge Fund Capital for Large Funds at September 2010

source: FSA
 
Parenthetically, the FSA survey suggests that hedge fund managers themselves own over $30bn worth of their own hedge funds.

Moore Capital's Bacon Tops the UK Hedge Fund Rich List

Each year "The Sunday Times" profiles the 1,000 richest people and families in the UK and the wealthiest 250 in Ireland. The list is based on identifiable wealth (land, property, other assets such as art and racehorses, or significant shares in publicly quoted companies), and excludes bank accounts (to which the paper has no access). The table below ranks the UK domiciled hedge fund managers in the List.

The big hedge fund winners, or at least gainers, in the last year have been:

• London resident and macro maven Louis Bacon is the first hedge fund manager to be credited in this List with a net worth in excess of a billion Pounds. George Soros, who maintains a house in London, has only failed to make the List now and previously because he is not domiciled here.
• Global macro clearly had a good period recently because Alan Howard (of Brevan Howard) is credited with an increase in wealth of half a billion pounds since the last ranking was compiled.
• The other investment strategy that is strongly represented at the top of the hedge fund List is CTA. BlueCrest founders Mike Platt and Bill Reeves are ranked equal fifth, coming  just after David Harding of Winton Capital. 

• Perhaps the only surprise is a calculation that the net worth of Arpad Busson of EIM has jumped by 71% in the last year.

Insight into European Hedge Funds from FSA Report

The FSA’s report, ‘Assessing possible sources of systemic risk from hedge funds’ was released today and is available from the FSA at http://www.fsa.gov.uk/pubs/other/hedge_funds.pdf. It offers some insights into leverage, margining, liquidity and the distribution of fund returns of the largest funds under the FSA's jurisdiction. The FSA regulates over three-quarters of Europe's hedge fund industry, so this is an insight into the whole of the European industry, by proxy.


Gross Exposure of London's 50 Largest Hedge Funds in October 2009

• There is a pronounced phenomena that fixed income funds (including credit L/S) need a larger gross to deliver alpha. Multi-strat funds typically have a fixed income sub-strategy. 
• Global macro funds weren't particulalrly levered in October last year - maybe they were largely out of bonds? 
• Interestingly, the classicly leveraged strategy of managed futures is unlevered according to the FSA's survey results.
• London's L/S equity funds had a smaller gross than their US counterparts in October.

Fund and Portfolio Liquidity of London's 50 Largest Hedge Funds

























Average Margin Requirements for London's 50 Largest Hedge Funds

• These are first tier hedge fund management companies, so would not suffer first from changes to margining rules by prime brokers. So the stability of margin requirements shown in October 2008 is perhaps understandable for them alone. That the margin requirements went up subsequently even for the top tier hedge funds shows the (lack of) availability of credit in 2009.

Distribution of Fund Returns of London's 50 Largest Hedge Funds in 6 Months to Oct 2009

• As much as anything else it is impressive how much the distribution of returns across the largest funds in the six months to October 2009 conforms to a (long) option-like payoff profile. Curtailing the downside and top-draw risk management is what investors in first tier funds expect and should get.

Change in Fund AUM of London's 50 Largest Hedge Funds over Six Months to October 2009

• All funds sufferred redemptions in the first half of 2009. The biggest and best funds had inflows in the second half of the year, but some London-based managers such as Lansdowne had excellent investment perfromance too. Those that performed well in 2009 had inflows and returns contributing to the growth in AUM.

Fund Total Number of Positions of London's 50 Largest Hedge Funds

• A few of the largest hedge funds in London have less than 50 positions in total.
• Most of the largest hedge funds managed from London, or where the fund management company if overseen by the FSA (like Moore Capital and Walter Capital, the SAC subsidiary), have 100-500 positions.
• Some of the multi-strategy funds engaged in statistical arbitrage or high frequency trading run portfolios with more than 5,000 positions. To put this in context there are around 3,000 different companies traded on the London Stock Exchange (excluding AIM).

source of all graphics: FSA

Industry Flows – Inference From Och Ziff Results Announced Today

Och-Ziff Capital Management Group LLC is a quoted company (Ticker:OZM), and as such we may get some insight into industry flows from their disclosures.


For sure, Och-Ziff is only truly representative of hedge fund management companies of its size, tenure, quality, and track record. In each of these regards OZM stands out. It is emblematic of the track record of Och-Ziff that, since the inception of the flagship fund, the Och-Ziff Master Fund has returned 14.5% compound (net of fees) to investors, which equates to a Sharpe ratio of 1.83.

Source: Och-Ziff Capital Management Group LLC

Och Ziff funds, like 60% of all hedge funds, hit new high-water marks in 2009. That, and by inference the returns achieved in 2009, and the size and quality of operations of Och-Ziff Capital Management drew in a disproportionate amount of industry flows last year. The big got bigger as a proportion of hedge fund industry assets in 2009 – this was not just a flight-to-safety argument, but every hedge fund in the world had capacity for new capital in the first half of last year as redemptions given in late 2008 came into full effect. So the biggest and best benefitted particularly because many of the hedge funds in that subset of funds had been hard closed to all investors for some time. Why not invest with Tudor, Moore and Och-Ziff if you can?

• Och-Ziff’s assets under management were $23.1 billion as of December 31, 2009, 4% higher than the $22.3 billion in assets under management as of September 30, 2009 but 14% lower than the $27.0 billion in assets under management as of December 31, 2008. The $3.9 billion year-over-year decrease was driven by net outflows of $8.1 billion, partially offset by performance-related appreciation of $4.2 billion during the year.


• During the 2009 fourth quarter, the $802 million increase in assets under management was driven by performance-related appreciation of approximately $497 million and net inflows of approximately $305 million.


• Assets under management as of January 1, 2010 were $23.5 billion, which reflected January 1, 2010 capital inflows (net of redemption requests received for December 31, 2009) of approximately $400 million.


• Estimated assets under management of $24.0 billion as of February 1, 2010, reflecting capital inflows of approximately $250 million and performance-related appreciation of approximately $250 million


The point to emphasise is that sequence of net investor flows for Och-Ziff went from $305m for the 4th quarter, to $400m for January 1st, to $250m for February 1st 2010.

Dan Och, Chairman and Chief Executive Officer of Och-Ziff, said “We believe that the capital inflow cycle for the hedge fund industry has begun, and that our assets under management will grow over time. Institutional investors remain extremely focused on manager selection, and we remain confident that our track record, infrastructure and demonstrated alignment of interests with our fund investors will continue to differentiate us in the marketplace.”

Dan Och’s statement about their own prospects of drawing investor flow might be true, but if Och-Ziff had smaller flows for February1st than those of January 1st, then the industry experience is likely to be significantly less positive for January and February flows.


HFN reported that there was a very small net outflow from the industry in December 2009, at a time when Och-Ziff was experiencing inflows. Och-Ziff inflows have moderated since. Does that mean that the industry has had further outflows in January?