The overseers of the $2 billion Fresno County Employees’ Retirement Association felt bold enough last summer to make a substantial move into hedge funds. In the months that followed, however, crumbling markets and dire headlines shook their resolve.
“Merely using the term ‘hedge fund’ right now has a bad connotation with the public,” says retirement administrator Roberto Peña, noting that the directors of Fresno, California–based Fcera have backed off their plans to put 9 percent of assets into hedge funds, reducing the target allocation to 5 percent.
Peña says he’s well aware that hedge funds as an industry have outperformed recently battered markets, but he worries about a potential backlash from simply being associated with the sector. “Going from basically 0 to 9 percent was a big jump, which we felt was a big public relations risk,” he explains. “Five percent will still have a big impact on the fund, and there will be some PR risk, but not as much.”
In August, before Lehman Brothers Holdings folded and money manager Bernard Madoff became a household name, Fcera decided to make its first significant hedge fund foray, though the system was already invested in a fund of hedge funds through a $10 million mandate with New York–based Blackstone Alternative Asset Management — an amount Peña calls “for all intents and purposes nonexistent,” considering the size of Fcera.
In addition to the 9 percent hedge fund allotment, changes adopted in August included cuts in the allocations to fixed income (to 21 percent from 33 percent) and equity investments (to 52 percent from 57 percent) and increases in those to private equity/venture capital (to 7 percent from 6 percent) and real assets (to 11 percent from 4 percent). But at a board of directors meeting on January 7, the plan’s consultant, Jeffrey MacLean, CEO of Wurts & Associates in Los Angeles, recommended a slight change in course, arguing that hedge funds might not after all be able to deliver the expected returns.
MacLean’s “concerns relate to the overall deterioration of credit markets and resulting financial delevering,” state the minutes from the meeting. “Because hedge funds are leverage-hungry entities, credit market conditions are making access to leverage more costly and difficult.”
Another consideration was MacLean’s belief that stocks and bonds would soon warrant more investment. “If you take a look at expected returns of more traditional strategies, they’re much more attractive than they were last summer,” MacLean tells Alpha. Thus his recommendation to sprinkle the leftover 4 percent originally targeted to hedge funds into equity and fixed-income allotments.
Both Peña and MacLean are quick to point out that they’re still cognizant of the virtues of hedge funds — the most important of which, Peña says, is the diversification they bring, “which is the reason we still want to move ahead.”
The board will pick three funds of funds from a list of five — New York–based Aetos Capital; Blackstone; Portland, Oregon’s Common Sense Investment Management; EnTrust Capital in New York and Chicago–based Grosvenor Capital Management — and spread its 5 percent allocation among them. (Because Fcera already has money with Blackstone, MacLean’s recommendation is that the fund retain that firm and hire two others to round out the mandate.)
Peña says that, in light of the effort to diversify, the board plans to take its time to make sure it hires firms whose underlying funds employ a wide variety of tactics, “so that we can get access to all the different strategies that are available.”
Like Peña, MacLean cites diversification as the main selling point of hedge funds, and he says he sees how some investors might think the time may be right to invest in them, considering the broad distress in the markets.
“Hedge funds have a role as part of a diversified portfolio,” he asserts. “Plus, we think that good hedge funds will exploit the current conditions in the marketplace — namely, in the credit markets.”
