Sometimes it’s better to be lucky than good. That’s how Richard Curtis, executive director of the $693 million Ohio Highway Patrol Retirement System, explains not just the fund’s shrewd decision two years ago to get into hedge funds in the first place — but also its subsequent choices on fund-of-funds hirings.
“We needed diversified revenue streams,” notes Curtis, who says that at the beginning of 2006, pension fund directors sensed trouble on the horizon. “Our assessment was that in the next three to five years, we would experience turbulent market conditions. I think the wisdom of the investment is borne out by the numbers.”
The bottom-line fear was that what Curtis calls the fund’s “traditional asset allocations” would not produce the minimum 8 percent rate of return the fund seeks. The move into hedge funds was prescient, though Curtis says no one at HPRS foresaw the depth of the current gloom: “We certainly never would have expected the things that we’ve seen here in the market recently.”
The system’s 6.8 percent allocation to funds of hedge funds has behaved generally as expected. Although it was down 8 percent this year through the end of September, that compared well with the 19 percent drop in the Standard & Poor’s 500 index for the same period. (HPRS’s overall portfolio took a 15 percent hit from January through September.)
“We’d certainly be happy if the hedge funds were positive,” Curtis says. “But they’ve been what we’ve expected them to be: noncorrelated revenue streams.”
Since the move into funds of funds, the portfolio has returned 2.2 percent (6.1 percent on its funds-of-funds portion); its main current fund-of-funds holdings are equity-based and include Evanston Capital Management’s Weatherlow Offshore Fund II and Protégé Partners’ Opportunistic Fund.
HPRS’s success shouldn’t be attributed entirely to luck. Curtis — who joined the pension fund in 1998, when its holdings consisted solely of stocks, bonds and some real estate — conducts a rigorous and somewhat atypical vetting of every fund of funds under consideration. Rather than expecting a fund-of-funds manager to do all the heavy lifting, Curtis researches hedge funds himself and then seeks out managers who can provide access to them.
“If you look at how a fund-of-funds strategy works — without being demeaning to the fund-of-funds people — I would say the rocket science exists at the underlying manager level,” asserts Curtis, who has presided over annual returns of 4.5 percent since he joined HPRS. “That’s why we select a given fund of funds based on who can give us access to underlying managers that have consistently done a good job.”
Curtis plans to take just such an approach to hiring a fund of funds to manage a $30 million mandate that HPRS hopes to salvage from an investment it had in an arbitrage fund run by now-defunct Lehman Brothers. The retirement system got 45 responses to a request for proposals that had a mid-October deadline; Curtis expects a decision by mid-December. In the meantime, he plans to visit several finalists to do due diligence.
The plan’s portfolio is divided into domestic equities (45.6 percent); international equities (14.5 percent); alternatives, including hedge funds, real estate and private equity (19.8 percent); fixed income (18.1 percent); cash (0.4 percent); and a strategy called a global tactical asset allocation (1.6 percent), which allows managers to move cash rapidly between asset classes in an effort to generate alpha.
Looking forward, Curtis doesn’t expect to make big changes in the portfolio’s allocation in response to the market meltdown and says his focus lies beyond the short term. “We’re interested in looking at 30-year numbers and 30-year liabilities,” he explains. “We won’t be reacting too quickly to market changes.”
