By Anastasia Donde
| Rick Shafer: We’re still doing funds of funds because we want to learn from them |
Pension plans making their first investments in hedge funds generally opt to either go directly into these funds or invest through a knowledgeable third party, like a fund of funds. The Ohio Public Employees Retirement System has decided to do both.
The $77.6 billion OPERS decided last year to put 3% of its assets into hedge funds, and the pension is planning to invest about two-thirds of that allocation into single-manager hedge funds and the remaining one-third with funds of funds.
Although many large pension funds have been going direct lately, Rick Shafer, the deputy director of investments for OPERS, thinks funds of funds can still be useful in helping staff and trustees to understand hedge funds, and can help with due diligence and risk monitoring.
“We’re still doing funds of funds because we want to learn from them and have them help us develop risk reports,” Shafer says.
The moves are part of an overall plan to revamp the OPERS portfolio, which lost 26.98% in 2008 and now manages some $6 billion less than the $84 billion it managed before the financial crisis unfolded in earnest that year. Until then, OPERS relied on in-house investment officers to manage about 65% of its assets, but since then, the plan has begun hiring external managers to help boost returns. OPERS has also begun to ramp up its investments in alternative investment strategies such as hedge funds, private equity and real estate, and it now plans to pour 25% of its assets into these strategies.
The pension had been branching out into more equity and alternative investments over the years, and Shafer says hedge funds are the next step in creating a more modern portfolio. “Historically, OPERS has had a predominantly fixed-income portfolio. Then it expanded into equities,” he says. “The lesson of 2008 was that we had too much in equities, which led to a very volatile result.”
Since then, OPERS has trimmed its equities portfolio—which now stands at 50% of the pension’s assets—to free up cash for alternative investments. For the alternatives portfolio, OPERS plans to invest 10% in real estate, 10% in private equity, 3% in hedge funds and 2% in opportunistic strategies. Shafer thinks the allocation to hedge funds and other nontraditional investments will continue to grow over time.
Shafer and his team, including chief investment officer John Lane, are not new to hedge fund investing. Shafer joined OPERS in 2009 from the New Hampshire Retirement System, where he held a similar role. He previously worked as the chief investment officer of the Alaska Permanent Fund, where he oversaw a $2 billion allocation to funds of funds set up as a customized separate account.
Lane, who joined last year, managed a sizeable direct hedge fund portfolio for the corporate pension plan at Kodak. OPERS also tapped John Blue to work exclusively on hedge funds earlier this year. He moved over from his previous role as head of global fixed income at the fund. Blue has 10 years of experience overseeing bond management at OPERS and is both a CFA and a CAIA charter holder.
In addition to Shafer, Lane and Blue, four other people from the external public markets team, which oversees external managers for traditional strategies, will work on the hedge fund allocation plan. OPERS has also brought in a slew of consultants to help shape its overall investment strategy. The pension has hired two consultants, NEPC and Hewitt EnnisKnupp, to advise the board on its general investment strategy as well as its alternative investment portfolio, respectively.
It has also hired a third consultant, Cliffwater, to assist with hedge fund manager research, due diligence and manager selection. The plan’s fund-of-funds managers are also expected to help out with risk monitoring.
The pension’s consultant for alternatives, Hewitt EnnisKnupp, will help it choose which strategies to invest in before the investment staff starts looking for investment managers. But Shafer says he envisions building a diversified portfolio that encompasses a variety of strategies, including long/short equity, macro, event driven and relative value, and tactical strategies such as commodities and distressed debt.
“It’s not going to be the strategy of the moment. We want strategies in all five sectors,” he says. Shafer expects to build some exposure to macro strategies to start with. “Global macro has been popular lately because it’s been a macro-driven world,” he adds.
Shafer and his group plan to seek out managers that can provide equitylike returns with bondlike volatility. The return expectation for the portfolio will be set at 4% over LIBOR or an informal benchmark of 7%. “We know that this is a different portfolio, and we expect different things from it, otherwise we’d just do a 60-40 stock/bond split,” Shafer says. For the funds-of-funds portion of the portfolio, OPERS has already chosen its managers, hiring K2 Advisors, Pacific Alternative Asset Management and Prisma Capital Partners for the mandate.
The investment staff chose K2 because it excels at risk management and quantitative analytics, Shafer says, while PAAMCO is good at choosing smaller and newer managers. Prisma combines a top-down, opportunistic view of the market with strong manager research and risk management, Shafer adds.
No managers have been chosen yet for the single-manager portfolio. Once the alternatives consultant has decided which strategies to recommend, the pension’s investment staff will decide which individual managers to invest in and will be allowed to choose managers without receiving approval from the OPERS board. OPERS has structured its investment approach this way for years, with the pension’s board setting overall investment policy and strategy but refraining from manager hiring decisions.
Trustees say this is because they don’t know enough about managers to feel comfortable making those calls, Shafer explains. When investing with single-manager hedge funds, the pension’s staff will be able to make investment decisions more quickly and avoid some of the bureaucracy typical of most other public plans, since the board does not need to sign off on every manager hire or allocation decision.
The hiring of Hewitt EnnisKnupp in April meant the pension had to consolidate its alternative investment consultants. OPERS previously used Hamilton Lane for advice on private equity and the Townsend Group for advice on real estate.
Shafer thinks having one consultant that works with all alternative asset classes is a better way to evaluate how these different strategies can complement one another. He also thinks one consultant will be better suited to offer guidance on strategies that are hybrid private equity/hedge fund vehicles or on firms that manage two or more alternative strategies, such as Oaktree Capital Management or Avenue Capital Group.
Shafer doesn’t think that having so many consultants, some of whom might disagree with one another, will pose problems.
“It’s a way to provide the board with a consultant that can give them an opinion on asset classes, while the staff is implementing it from a bottom-up perspective,” Shafer says.
Trustees even like working with two consultants, he adds. “They’ll encourage a second opinion, even if it becomes a disagreement, because it’ll give them more perspective,” he says.
