By Anastasia Donde
Photographs by Joe Wigdahl
Thomas Macina: We spend a lot of time and effort around negotiating |
Who says funds of funds aren’t pushing back? Mesirow Advanced Strategies, the $13.6 billion Chicago fund of funds, now has strict guidelines for hedge fund managers’ terms, fees and arrangements. Maybe that’s why it is one of the few funds of funds to bounce back since the crash. The funds-of-funds arm of Mesirow Financial lost as much as $4 billion during 2008. Even though it’s still $2.5 billion shy of its peak at the start of 2008, Mesirow has been steadily growing since June 2009.
The growth—and newfound stringency—has come under the watch of Tom Macina, who became president in July, 2009. As an example of Mesirow’s tougher approach, Macina says he’s looking at managers’ investment in their own funds, saying that managers shouldn’t have better liquidity than their investors—a complaint of many during the 2008 crash.
“We’re considering a manager right now that has no great mechanism in place by which we can be assured of their level of personal investment in the fund and specifically being proactively notified should their level of personal investment change in a way that it’s too late for us to do anything,” Macina says. Instead of walking away, however, Mesirow is negotiating a new term that will require the manager to notify it in advance should the manager redeem any of its capital or should its investment go below a level that’s comfortable to Mesirow.
This is just one of the many issues Mesirow is confronting. Last May, these were outlined in a set of internally published “guiding principles,” as the firm calls them. In addition, Mesirow insists on third-party fund administration, separate valuation and audit services and independent boards who act in the best interest of the fund and its investors.
Its principles are a laundry list of the types of changes needed to address what most investors have complained about for years. The firm also suggests using asset-weighted management fees where appropriate and hammers that performance fees should be designed only to reward outperformance. The principles also state that managers should make their best efforts to liquidate positions immediately to fulfill redemption requests.
Macina says Mesirow decided to invest heavily in operational due diligence, analytics and technology about six years ago—and it wants to make sure the hedge funds it invests in are likewise well equipped. Mesirow is asking for monthly reporting from managers on exposures, profit and loss data, risk management metrics, portfolio drawdown estimates, counterparties, leverage and financing risk. It also insists that a fund it invests in should report full security level transparency to an independent party that will provide aggregated risk reporting to investors.
Begun as a hedge fund advisory service catering to insurance companies by Howard Rossman in 1983, Mesirow formally became a fund of funds and a registered investment advisor in 1990. During the past 20 years, however, it has diversified, and most of its assets now come from corporate, public and union pension funds. The rest are from sovereign wealth funds, central banks and insurers.
Based in Chicago, Macina oversees both the investment and business strategy. Previously, he was head of research at the firm, which he joined in 2003 from hedge fund Compass Asset Management, a $300 million multistrategy hedge fund that dissolved a year later. Macina previously held a variety of roles at investment banking and strategy consulting firms.
AR staff writer Anastasia Donde recently caught up with Macina to discuss the changing role of hedge funds in institutional portfolios, strategy decisions and funds’ willingness to cater to client demands. “We have a saying around here that it’s a privilege and not a birthright to manage client capital,” Macina says. “That’s at the core of how we think about what we’re trying to accomplish. It drives everything that we do in terms of building portfolios and trying to engage our clients in the most thorough way we can.”
AR: There has been a lot of pushback from pension funds on fees to funds of funds like you as well. How are you coping with this?
| Thomas Macina: It’s a privilege and not a birthright to manage client capital |
Tom Macina: We generally give our clients the option to choose a hybrid fee structure (including a management fee and a performance fee) or a flat-fee structure. In the last year or two, institutional clients have generally been favoring hybrid fee structures that better align incentives. And we’re absolutely fine with it and think it makes all the sense in the world. Last month, a big pension fund client wanted a performance fee geared around outperforming inflation. So they’d be paying for performance over the inflation rate. Here the incentives are totally aligned. On the manager side, we’ve undoubtedly spent a lot of time, particularly in the last couple of years, making sure we get fee arrangements that are appropriate for the mandate, where the incentives are aligned and are the best ones possible vis-à-vis passing those fee arrangements along to our clients. So we’ve got nonstandard fee arrangements with a very meaningful fraction of our capital.
AR: You also mention the importance of research and due diligence. How do you structure this?
Tom Macina: It is geared to forming expectations as to how risk is going to be taken and how a manager is going to get compensated for taking those risks. We’ve got research teams that are focused on different segments and geographies. They are focused on the investment approach, the integrity of the organization, and the robustness and repeatability of the process.
We also have a quantitative team that approaches things from a different angle. Their job is to approach the situation more dispassionately and really take the view of saying, “I don’t care what the manager claims to do, show me the data. And let me see that they’ve taken the risk and gotten paid for taking the risk in the way that we expected.” And frequently there is a disconnect between the findings of the two groups. What we’re looking for is consistency in qualitative due diligence observations and analytical observations.
We also have an operational due diligence team, and importantly, that’s not a new phenomenon. We separated ODD from investment due diligence in 2001. They’ve always had an unquestionable veto in our investment process. We’ve got seven people whose job it is to make sure that the organizations in which we invest do things in a robust manner. The operational due diligence team effectively does checks on the underlying organization and back office and control environment.
The members of our strategy working groups are the most senior members or our investment teams. They’re making the final decisions on whether we’ll hire a manager, put a manager on watch or terminate a manager.
Every one of those voting investment committee members has a veto over any manager decision. There are a lot of checks and balances with respect to the risk management process.
AR: Did you make any changes to your due diligence process
after 2008?
Tom Macina: We started to more heavily scrutinize the arrangements between the provider of capital and the manager of capital—meaning us and the manager—and be extra careful around that arrangement. I mean governance, incentives, transparency and liquidity structure. We spent a lot of time and effort around negotiating those arrangements in a fair and appropriate way.
AR: How do you monitor risk exposures in your portfolios?
Tom Macina: We rely primarily on our proprietary analytics and architecture. We do use a third-party vendor, Measurisk. They complement our analytical approach, but we don’t rely primarily on data that we get from them. We’ve developed a lot of systems and analytics thinking about separating skill from luck in evaluating managers. And we have the ability to look at manager risk, manager exposures and manager performance, and think about the separation of alpha and beta. We do customized benchmarking for all of our managers in good standing, and that attribution exercise is critical in trying to understand whether or not managers are taking risk and getting compensated for risk in the way that they expect and the way that we believe. We do this manager by manager, but we can also aggregate that at a portfolio level. So at the end of every year, we can show our clients where we believe their performance came from, how much of it came from different risk exposures, which came from alpha and how much of it came from beta, if any.
If a client came to us and said, “Hey, we’re thinking about this investment. Will you help us?” and it’s not an investment that’s in our portfolios, we would be willing to assist them with their evaluation as long as we can get information from them and the manager freely.
AR: How often do you look for new managers or have turnover in your portfolios?
Tom Macina: Historically, our capital-weighted turnover has tended to run 10% to 15% per year. That was higher in late 2008 and early 2009, and is generally higher in environments where risk premiums are moving around very substantially.
For example, we went from a 4% dedicated short strategies allocation in late ’07 to 15% dedicated short strategies in late ’08 and back down to 5% in early ’09. We felt like we needed to add to this area substantially at the time.
And more broadly, I’d say that if you’re going to do what we do successfully, as complicated as hedge funds are, there are ultimately two levers you can pull:
the allocation lever and the manager choice lever. It is our opinion that over long periods of time, probably two thirds comes from the manager choice lever and one third from the portfolio allocation lever. At times when risk premiums are moving around a lot, that can be flipped. Late 2008 and early 2009 are good examples of that.
AR: Are there any strategy additions or subtractions that you’re looking to make in the near term?
Tom Macina: Right now we’re relatively constructive on equity strategies rooted in corporate activity. Certainly a lot of cash is sitting with technology companies; a lot of it is sitting overseas and can’t be easily repatriated. Globally, there is a lot of cash on balance sheets, and I think that there are going to be more opportunities for activity to happen, be it deals, dividends or share buybacks.
We are closely following event-driven equity strategies right now. This would include managers that pursue M&A or merger arbitrage strategies, as well as those that are in a position to take advantage of, and potentially even influence, other forms of corporate activity, such as strategic acquisitions/divestures, special dividends or share buybacks.
We have been evaluating macro and commodities strategies for the past few years. There is a specific flavor of those macro and commodities strategies that we like. I’d say in the macro space, it’s only a subset of the macro universe that we would consider. A lot of those macro managers tend to have big fixed-income books, and those books tend to be highly levered. If there is one philosophical stronghold that we have, it’s that we don’t like managers that employ a lot of leverage. The macro or commodity managers that we’d pursue would be discretionary and not have a lot of leverage attached to them.
AR: What else do investors want?
Tom Macina: Today almost half of our capital is in customized mandates. There is a deliberate conversation with clients around performance profiles sought, risk parameters sought, liquidity horizons and all of those things. But it’s not as if one year, all of a sudden, the switch flipped. It’s been a gradual and certain change of the direction of the business.
AR: How do you go about building customized portfolios?
Tom Macina: The mentality is not to create all sorts of new products and then sell them. It’s much more geared toward engaging with a client around what is the problem they are trying to solve or the purpose they’re trying to achieve, and how do we construct a portfolio that accomplishes that. We have lots of customized accounts that have different profiles depending on the goals, objectives and risk parameters of the client.
You can see clients starting to bifurcate portfolio management decisions in different ways. This view of the world is growing and becoming a little bit more prevalent, where clients are not thinking of hedge fund programs as off-to-the-side hedge fund buckets, but thinking about them as active risk components in the context of their equity or credit portfolios.
For example, a prospective client recently came to us and said they want to pursue a multistrategy mandate with a relatively flexible profile and a hedged-equity-only mandate which they would use not just in the context of a hedge fund allocation but in context of an actively managed equity portfolio. This is a common situation. On the multistrategy mandate, they wanted us to look at it with no hedged equity or to only use opportunistic hedged equity strategies with long or short biases.
AR: Do customized accounts take up more work and time on your part?
Tom Macina: We don’t have six different portfolio managers independently picking from a pool of managers to construct portfolios. We have a group of people, led by our chief investment officer, who have the responsibility of constructing portfolios. So I don’t think about it as being this binary distinction between the two, at least as it relates to portfolio construction from a cost perspective at all. Even pooled mandates have different profiles and parameters around them.
AR: If institutions want to access specific strategies, can’t they do it on their own?
Tom Macina: We’ve had clients over the years that have thought about going direct or partially direct, and they’ve come to realize what that entails—how much effort and experience that requires. As clients think about this and realize what it requires to do that, they come to appreciate our value proposition even more.
A big part of that is the investment research outsourcing. When we put portfolios together, there are 25 to 30 people involved in operations and accounting. Staying on top of operational issues is not insignificant. We’ve invested millions of dollars and had many people developing analytical and technology capabilities. We made the decision five to six years ago to invest heavily in this area. It plays an enormous role in evaluating managers and building portfolios. When clients see that, they recognize how valuable it is to making investment decisions, be they manager decisions or portfolio decisions.
