After a year of market meltdown and scandal, many investors are looking more askance than ever at hedge funds.
But not every shift has been toward skittishness. Mansco Perry III, CIO of the $27 billion State Retirement and Pension System of Maryland, says that he hadn’t been a proponent of hedge funds but that their doggedness in 2008 impressed him.
“I’m probably an outlier, but they’ve made more of a believer out of me than I was before,” says Perry. He points out that although hedge funds as a whole didn’t deliver positive returns, they beat the equity markets. The Standard & Poor’s 500 index was down 37 percent last year, roughly twice the 18.3 percent drop in Hedge Fund Research’s HFRI composite index.
Perry joined Baltimore-based SRPS last April after a decade as deputy CIO at the Minnesota State Board of Investment, where he says the rule was to avoid hedge funds. When he arrived at the Maryland system, which administers death, disability and retirement benefits for about 350,000 active and former public employees — teachers, law enforcement officers, judges and legislators — the portfolio included a 5 percent “opportunity allocation,” which held Pacific Investment Management Co. bond funds that focused on generating a real return and direct investments in three hedge funds: Barclays Global Investors Global Ascent Fund, Bridgewater Pure Alpha Fund and Mellon Global Alpha Fund.
Six months into his new role at Maryland, Perry oversaw a major asset reallocation that expanded the system’s exposure to alternatives. Public equity exposure was slashed to 37 percent from 57 percent of holdings, and the fixed income was reduced slightly, to 15 percent from 17 percent. The private equity target allocation jumped to 15 percent from 5 percent, and real-return assets (commodities, energy, timber and infrastructure) doubled to 10 percent. The opportunity allocation — renamed absolute return — was also doubled, to 10 percent, and devoted primarily to hedge funds; the system has $730 million in hedge funds, leaving about 7 percent of this allocation unfilled. Real estate was held at 10 percent, and cash was increased from 1 percent to 3 percent.
SRPS’s portfolio fell by 29 percent last year. At the end of October, as Perry was putting the finishing touches on the system’s new allocations, the Rockville-based Maryland Public Policy Institute and the Calvert Institute in Baltimore released a report warning that SRPS was $11 billion underfunded, and that such a deep liability could increase the cost of state borrowing. But Perry says that such issues don’t necessarily affect his investment philosophy: “Our primary concern is always that we generate the best returns that we can, given the resources that we have” — and that is where he hopes alternatives will pay off.
“I think the key to tackling this mandate successfully,” he adds, “will be a function of manager selection. We’re looking for good managers that we believe have significant internal infrastructure and risk management, and we’re also reviewing their client lists.”
Perry says that the Ponzi scheme in which Bernard Madoff is accused of bilking clients of $50 billion in assets hasn’t changed the way he goes about his selection process but that it underscores the importance of due diligence.
“My approach has always been to be highly selective in whatever we’re looking at,” he explains. “If I don’t know how managers invest, I don’t know how I can invest in them.”
He notes that because of staffing constraints, the next few hedge fund additions at the pension system will most likely be made through funds of funds, which require less in-house involvement than do direct investments.
“We want to learn and improve our insight and understanding of the marketplace,” Perry asserts, “and we believe that partnering with funds of funds would probably be the easiest way to facilitate that.”
He concedes that the Madoff scandal, which ensnared thousands of investors — individual and institutional — was fueled in large part by a handful of funds of funds, but he sees malfeasance as a perennial hazard.
“I don’t believe anyone can ever be 100 percent certain they’ll be immune from fraud,” Perry says.
