In the past several months, a number of large US public pensions have allocated assets to global macro and commodity trading advisors.
In March, the New Jersey Division of Investment made a $200 million commitment to BlueCrest Capital. As of year-end 2011, it had $150 million with Brevan Howard (global macro), $97.5 million with Lynx and $128 million with Winton Futures Fund (managed futures).

Also in March, New York City pension funds made their first direct allocations to hedge funds. Among those receiving $350 million allocations was Brevan Howard.
Late last year, Massachusetts Pensions Reserves Investment Management allocated $25 million each to Brevan Howard, Winton and BlueCrest Capital Management (managed futures).

In the fourth quarter of 2011, Texas Teachers Retirement System allocated $400 million to AQR Delta Offshore Fund (managed futures) and $160 million to Graham Global Investment Fund (managed futures).

Texas County & District Retirement System allocated to Brevan Howard, Caxton (global macro), Graham Global Investment Fund and Winton Futures Fund.

Last October, Illinois Teachers’ Retirement System allocated $15 million to Flintlock’s Commodity Opportunity through its emerging managers program.

Last October, New York State Common Retirement Fund allocated another $55 million to Brevan Howard and $50 million to COMAC Global Macro Fund.
California State Teachers’ Retirement System, which approved a $200 million allocation to global macro in 2009 and hired Lyxor Asset Management as an adviser in December 2011.

2011 versus 2012
Michael Bernstein, director and head of US pensions and consultants at Lyxor Asset Management, observes that 2011 was a very difficult market for many hedge fund strategies. “In that environment, we saw a noticeable demand for global macro strategies followed by managed futures. They were the top two strategies that investors were demanding – broadly as well as within the Lyxor managed account universe.

The Lyxor platform has about 100 managed accounts and a significant percentage of those are managed futures and global macro… The macro funds were of heightened interest last year because people saw it as a market environment where some of those top down economic decisions were important. Investors were leaning toward managers that were willing and able to make those top down calls and macro was the best strategy for that.”

Bernstein notes that there has been a noticeable difference this year. “We see more evenly distributed demand for different strategies and a lessened demand for macro and CTAs. Some market participants feel we’re in an environment less determined by these large macro factors – though that can change week to week.
It has been a more stable environment. Some of the geopolitical fears are less than they were last year. When that happens, you have more opportunity for stock picking, security selection of all kinds, you get back to bottom-up fundamental investment work. When you have that, you have the opportunity to make money on other types of strategies such as equity long/short, credit long/short and other hedge fund strategies.”

Strong interest in CTAs
A lot of money has flowed into CTAs, particularly some of the larger CTAs. “Some investors look at them as a basket of tail risk protection strategies. We are seeing more interest in baskets of CTAs as they have different time frames and models. We’ve seen interest in that for the past 12-18 months,” says Bernstein.

CalSTRS
CalSTRS selected Lyxor as its advisor for a concentrated portfolio of macro funds. It does not include CTAs.

Bernstein says the initial portfolio is somewhere between five and six funds. “We’re helping them figure out which funds are appropriate. This is a trial – if the program meets its goals, it could be expanded in three years. They are trying to find investments that are good complements i.e. not correlated to the rest of the portfolio. They are studying the tactical asset allocation techniques of some of these managers and trying to potentially use some of these techniques in their broader portfolio.”

One investment has been made. Two will be made shortly. Between July 1 and end of year, the rest will be launched. All the initial funding will be done by the end of the year. The end of the trial period will be in another two years.

Bernstein says this project is different from most of the work they’re doing with other investors. It is a dedicated macro portfolio. “We’ve had very strong demand from many different large institutions for macro managers – both managed accounts as well as traditional investment vehicles,” he adds.

James Twiss, managing director of the Americas at First State Investments, says, “We used to see a lot more home country bias in a number of our markets including Australia, but now there is growing interest in international global products.”

The Australian investor has always had a high equity bias. About 60% of the money they invest goes into equities – 35-40% goes into Australian equities and the rest into international equity.

Hedge funds are a small but growing market in Australian superannuation funds. Estimates are that comprise $35 billion of the $1.4 trillion market.
Some of the superannuation plans which are very interested in hedge funds might have 20-30% allocated but there are not many like that, says Dunnin. Non-for-profit funds are most comfortable with hedge funds’ lock-up periods and have a long term focus.

Dunnin says, “Australian superannuation plans are more wary of hedge funds. They didn’t deliver non correlated returns during the global financial crisis.”
Downward pressure on fees

There continues to be downward pressure on fees. Twiss takes the view that the jury is still out on the fees hedge funds, as a sector, can charge. “Certainly there are good hedge funds out there who continue to do well. But the sector on the whole faces tremendous headwinds when it is trying to compare performance net of fees to a traditional manager.”

The reason why Australians are conscious about fees is that joining a superannuation fund in Australia is compulsory. The government should be doing all they can to make sure fees are as low as can be, within reason.
There is a growing perception among superannuation funds that the manager should be charging flat fees. They say: “We will give you $700,000 to run a $10 million mandate. If the amount gets bigger, we’ll give you an additional fee.”

Dunnin says the big concern is not the investment management fees, but the financial planning fees. There is huge pressure on those. Government reforms are focused on that.

Reduced role for consultants
Funds in Australia used to be dominated by the investment consultants such as Towers Watson, observes Dunnin. These are very influential. “Increasingly, as superannuation funds get bigger, the superannuation funds realize they need to develop internal expertise. They will bring in consultants as needed but will want their own people who can understand what the funds are offering them. Five years ago, they would probably play off two to three asset consultants to get their best investment ideas and advice.”

Dunnin says consultants, by definition, are conservative. “They don’t lead, they follow. Superannuation funds had to almost show the consultants how they should be looking at that sector.”

Australia also has one of the fastest growing pension fund industries the world. Australian pensions grew by 17% (US dollar terms) in 2011 compared with 2001. The growth is largely due to the compulsory salary contribution made by every worker.

The superannuation sector is one of the most developed and sophisticated in the world at almost 100% of GDP. Australia also leads the world in the adoption of defined contribution funds.

In the December issue of Investor Focus, Infovest21 interviews one superannuation fund and two Australian consulting firms. The preference is to invest directly with hedge funds.

Mathew Jeremy of Caravel Asset Management says while they have used funds of funds, they prefer to use individual hedge funds and construct bespoke portfolios of them for our clients. Andrew Vallner of CPG Advisory says they generally invest in hedge funds. “We prefer higher volatility than the traditional funds of funds model.”

Jeremy observes that the key features of the Australian landscape at the moment are a strong desire for lower investment management fees and greater transparency of the investment product and process. “This helps to explain why fund of funds have found the Australian market more difficult in recent years. There is definitely a tendency for the larger institutional investors to choose hedge funds themselves and build their own portfolios,” says Jeremy.

Jeremy says the superannuation industry in Australia is still under-invested in hedge funds compared to other countries and compared to what is likely to be necessary given the demand for more consistent returns that are less dependent on equity markets.

Some estimate the average allocation to hedge funds in the 3-3.5% range.

Preferred strategies
Jeremy expects the macro environment to continue to be challenging over 2012 and 2013. He expects to see below trend growth with declining inflation and easier monetary policy around the world. Heightened levels of uncertainty among investors and volatility of risky assets are likely to continue. At the same time, he thinks global sovereign bond markets offer poor risk-adjusted returns.

In this environment, he is advising clients to consider emerging rather than developed equity markets, defensive or franchise stock portfolios in long-only equities, and selected hedge fund strategies. “The hedge fund strategies we prefer include global macro, equity market neutral, special event and orthogonal (fundamentally uncorrelated with equities) strategies not dependent on equity markets,” he says. “We think the environment over the next couple of years should be particularly favorable for good global macro managers. That and good emerging markets equity managers are top of our “must find” list at the moment.”
Vallner notes that high quality but smaller funds are generally preferred over mega funds, especially where the manager has a track record with large volumes and is unlikely to outgrow their abilities.

Full interviews are available in the December 2011 issue of Investor Focus.

Josh Kaplan, former chief investment officer of Drexel University was hired in February 2010 to manage the hedge fund allocation at Ascension Health-Catholic Healthcare Investment Management Company.

Catholic Healthcare Investment Management Company was started in January 2011 to manage the assets of Ascension Health as well as a select number of current and potential outside institutions. CHIMCO is a wholly owned subsidiary of Ascension Health, which is the largest nonprofit healthcare system in the country. CHIMCO manages roughly $20 billion of which $17 billion belongs to Ascension Health. CHIMCO has 20 associates at this time.

Infovest21: What is the role of hedge funds? How does it fit into the portfolio?
Joshua Kaplan: The hedge fund allocation is divided into two categories: absolute return and directional. The absolute return book is designed to demonstrate minimal beta exposure, little correlation to the public markets and generally low relative volatility. This is in contrast to the directional book, which typically exhibits more beta and higher volatility. Practically all of the underlying strategies in the absolute return book are found in the deflation/recession bucket. The strategies in the directional bucket tend to deviate a bit and are mostly classified as growth or inflation investments. Overall, we expect the hedge fund portfolio to possess risk-adjusted performance superior to most of the other asset classes.

Infovest21: What is the asset allocation to hedge funds? How has it changed over the years?
Joshua Kaplan: When I started at Ascension, I inherited a hedge fund allocation of roughly 15 funds that comprised 7.5% of the overall portfolio. The newly created investment policy statement sets a target of 22.5% to hedge funds of which 12.5% belongs to absolute return strategies and 10% to directional. Consequently, there was work that needed to be done to boost the allocation to its target and shape the hedge book according to the strategic blueprint put in place. After nearly two years, the hedge fund allocation is only a couple pieces away from where we originally envisioned it. Today, the portfolio is fully diversified, well positioned going forward and contains high conviction, opportunistic strategies that we strongly believe will add alpha.

Infovest21: Where do you see opportunities and do hedge funds fit in?
Joshua Kaplan: Currently, I am focused on finding a dedicated European distressed strategy as an opportunistic play for the directional bucket. I believe that the crisis in the European Union should lead to several attractive places to allocate. With the banks being forced to recapitalize and required to hold 9% tier one capital, there is going to be an enormous supply of stressed and distressed paper hitting the market. I’m looking for a manager that has the compulsory skill set to be able to source attractive deals and sort through the supply to identify strong investments at distressed prices. Finding a seasoned and successful distressed manager in Europe is very difficult as the region has not had the same history with those cycles that we have had here in the US.

The full interview can be found in the current issue of Investor Focus.

Jordan Foster, who is responsible for marketing and client relationship management for North America and South America at Marshall Wace Asset Management, says that hedge funds have generally become more transparent, often provide holdings (in some form, usually with a lag) to investors, and are now more clear regarding expected return/risk characteristics and value added in terms of alpha and beta.

What institutions want
Institutions are looking for a strategic partnership where they can get your [consultant/fund of funds’] thoughts on financial markets as well as due diligence information, Lukomnik adds.
Both hedge fund managers and funds of funds say institutions are looking for more customization.

“Institutions, recognizing the robust, unique intellectual capital at many hedge funds, are increasingly asking larger hedge fund managers to ‘co-construct’ long-only solutions for them,” says Foster. “These solutions often provide a complement to traditional long-only managers, with the expected effect of improving information ratios of their total portfolio.”

Lukomnik emphasized that manager’s terms and conditions need to line up with the strategy. For example, with a long/short equity fund, there is no need for a three-year lock-up. By contrast, if you’re running an activist strategy, people want a lock-up.
Institutions are also now scrutinizing the manager’s back office as a condition to allocate assets.

Large managers vs small managers…issue of crowded trades
Recent HFR statistics indicate that two-thirds of Q2 2011 asset flow went to hedge fund managers with assets over $5 billion. Speakers at the seminar generally thought that trend would continue as larger managers provide more comfort and less career risk to the institutional investment staff. Lukomnik also pointed out that more extensive operational due diligence must be done on smaller managers than larger managers.

However, institutional investors are trying to find creative ways to gain access to emerging managers as studies show that young, smaller managers outperform.

“This is an area that our institutional clients continue to be very interested in. Definitions of emerging manager vary – size could range from $500 million to $2 billion,” says Rock Creek Group’s Sherri Rossoff.

Furthermore, as the very large hedge funds reach capacity, investors need to look at the next level of hedge fund manager, said Mihir Meswani, chief portfolio strategist/risk management director at Sandalwood Securities.

One of the implications from relying heavily on larger managers is crowded trades as many managers are investing in the same holdings, says Meswani.
One problem is exiting those trades. “With liquidity only a sometimes thing for the past few years, it’s the exit from crowded trades that has mattered,” says Lukomnik. “If there is liquidity at quarter-end in a trade that has worked, look out. Everyone heads for that exit at the same time, because they’re selling what they can.”
Rossoff points out that smaller managers tend to find investment opportunities that are different from larger managers, which among other characteristics, helps differentiate them.

Evolving role of fund of funds as solution provider
The general consensus was there will always be a role for funds of funds particularly for smaller institutions and family offices that can’t make $50 million allocations.
“The role [of Rock Creek] is more than simply picking managers from a database,” says Rossoff. Funds of funds proactively manage portfolios in terms of top-down positioning to avoid systemic risks and quickly take advantage of new investment opportunities with an experienced team that understands underlying positions as well as the markets generally.

“Funds of funds will increasingly be a solutions provider. Some family offices want to use us as their research arm. Some institutions may ask us to provide a tail risk solution,” adds Meswani.

Differentiated fees, not lower fees
Small institutions are increasingly using hedge fund style mutual funds. Lukomnik points to their strong growth. In 2009, there were 104 hedge fund style mutual funds. Today, there are about 198 – almost double. That represents $163 billion in assets – they are not charging 2/20 fee.
Rossoff points out that while a goal may be to negotiate the best possible fees, she would be cautious about managers dropping their fees too fast and sacrificing their ability to maintain a solid business operation.

Some fee structures that look too good to be true are. For example, a manager who says it has no management fee, just a success fee and “expenses,” could actually be exceptionally expensive if those expenses include salaries and bonuses, says Lukomnik.
There will be pressure for differentiated fees, not necessarily lower fees, says Lukomnik. “The few managers who are good, who are willing to close their funds, will be able to get high fees. Others will not.”

Jordan says, “We (Marshall Wace) have not seen significant fee pressure. I believe that is true for other managers who do not have unlimited capacity. That said, many seem to believe the institutional fee structure will settle somewhere near 1.5%/20 – closer to pre-2000 levels. Some investors have asked for an option to soft-lock assets for two or three years in exchange for a modest fee reduction. I believe this alignment of interests makes sense.”

Foster expects we will see more creative fee proposals, ones that reflect a strategic partnership (more explicit sharing of alpha). “Hedge funds seem to be migrating from a ‘DDQ culture’ (one where hedge funds are more resistant to fluid information exchange with prospective investors) to the ‘RFP culture’ prevalent in the long-only world (where managers are more responsive to detailed questions regarding their investment and operations processes).”

2011 versus 2008
Susan Webb, founder and chief investment officer of Appomattox Advisory, observes a couple of major differences between now and 2008. “First, we’re starting from a lower base of capacity utilization and chances are we will not return to that level. Utilization in the US dropped by 50%. The US has recovered about half of that. We will probably only slowly recover the remainder over the next six years. Second, even though banks haven’t fully restructured, they are in much better shape now than they were in 2008. They can potentially start lending. Credit hasn’t been extended to smaller companies until this last quarter. We will just begin to see the rollover of some of the high yield debt next year.”

Webb believes US pension plans will have to lower their expected returns as its going to be a difficult 10 years. “This realization is currently understood by most plans,” she says.

Rob Picard of Boxtree Capital, a consulting firm, points to another difference between now and 2008. There was a lot of leverage in the system in in 2008. Corporate and consumer is much less leveraged now. The government threw a lot of money in the economy and now corporate America is sitting on a lot of cash. This cash needs to circulate which would be stimulative.

Similarities/differences between US and Europe
The big issue in the US and Europe is growth, says Webb. Leverage has funded growth over the past several years but will not be available in the future to do so. “In Europe, the debt is due more to the large pension obligations and misallocated investments. Some managers are calling for a depression in southern Europe. In northern European, like in the US, we are expecting slow growth of about 1.5%-2%,” she says.

Webb points out that Europeans save 15% compared with 5% in the US. While the US has significantly improved its saving rate and reduced each debt burden, individuals still have significant debt overhang. Hopefully, the changes in savings rate will remain at elevated levels.

Picard is negative on Europe. Because the European Union is so different structurally from the US Federal Reserve System, he thinks this will bode well for the US. “The money will flow from Europe to the US. There will be a huge arbitrage from the US perspective. It is hard to get the timing right. How do you make money and survive in that time?”

Webb sees many investors pulling their deposits out of the French banks. France may have to nationalize their banks in order to support Italy and maintain the EU. She predicts that the euro could breakup in two years if a mechanism for orderly exiting of countries is not put in place.

Going forward
Webb adds if they don’t write Greek debt down 10 to 20 cents on the dollar and allow the Greeks to remain within the EU, there will be a massive depression in Greece similar to what happened in the US in the 1930s. “The Greeks, at this current moment in time, cannot support the debt burden by reduction in spending alone. They need a euro bond structure where each country has a certain percentage depending on their GDP and fiscal responsiveness. That will necessitate a political alliance which they still don’t have and a governing and monitoring group to represent the EU,” she says. Picard’s view is that once there is a clog in the system, it takes a while for the whole system to clean itself out. “We are on the road to recovery. There is a lot of frustration in Washington DC, Wall Street and Main Street. The three groups need to agree and clarify the regulations. Once corporate America understands where we’re going regarding regulation, we will see money come back in.”

Picard thinks they’ll get it right shortly. He sees a number of positive factors on the horizon. “The European countries may come to a consensus. It doesn’t happen overnight – it takes time. Washington might start to work together over the next 12 months. And there are some exciting things going on the economy such as developments in technology, pharmaceuticals and energy. These are game changers,” says Picard.

The UCITS III hedge fund industry has grown with lightning speed from about nothing 18 months ago to over 500 UCITS hedge funds today with the pace of expansion accelerating. Estimates are that assets in hedge fund UCITS are about $45-55 billion while Eurekahedge puts assets even higher, closer to $100 billion with close to over 990 funds.

Eurekahedge says UCITS hedge funds account for 7% of total hedge fund assets but attracted 20% of the net inflows in 2010.

UCITS III funds comply with the European Union directive. The acronym stands for Undertakings for Collective Investment in Transferable Securities

The UCITS structure sits very well with institutional portfolios, observes Ballos. “Institutional and family offices investors wanted a regulated, liquid, multi-advisor fund, offered within the UCITS framework, with the added safety of independent risk controls.”

Philippe Dupuy of Alternative Advisors agrees. “UCITS funds offer investors an investment vehicle that satisfies almost all expectations and requirements they’ve been fighting for and struggling to get from offshore unregulated funds – liquidity and transparency.”

The liquidity aspect allows institutional investors to better time their investments according to their macro views, allowing them to tactically allocate.

Dupuy says the nature of the underlying investment is, by definition, more liquid because of strict rules about gating or side-pockets. “Note that side pockets are not allowed in France, allowed only for daily funds in the UK, and negotiated on a case-by-case basis in Luxembourg. In a liquidity crisis, we will get out, though probably not as quickly as anticipated, as gates can be imposed on UCITS funds.”

Bi-monthly liquidity is the minimum requirement but the majority of funds have daily or weekly liquidity.

Chris Rule of Key Asset Management observes that equity long/short is the most developed strategy within the UCITS world. Less liquid strategies such as distressed investing are absent from the UCITS III hedge fund universe and are likely to remain so.

Caution required
Despite the advantages, industry veterans caution investors when looking at new UCITS funds and at UCITS wrapped hedge fund strategies. Not all hedge funds are suitable for the structure. The underlying fund needs to be liquid. Equity long/short and managed futures can fit in a UCITS structure easily while distressed and fixed income arbitrage don’t easily fit.

“Some managers are just surfing the Newcits wave and launching a UCITS even though their core strategy is not transferable, thus moving away from their core competencies,” says Dupuy.

Some strategies are “shoe horned” into a UCITS structure that may not fit well. If so, investor may be buying products that are riskier than they thought. UCITS funds promise liquidity which make it reassuring for investors. A major concern is that the liquidity of some underlying investments may not be sufficient to allow UCITS funds to provide daily liquidity.

A liquidity mismatch may exist between the instruments they invest in and the liquidity they offer investors,” says Dupuy.

Others point out that some managers will change their strategies i.e. reduce leverage or invest in more liquid assets to fit into the UCITS structure.

They argue that negative selection bias exists. Managers who can’t attract assets themselves may rely on big demand for UCITS III funds to attract investors.

Another danger is attracting institutional investors into a retail product as both groups have different objectives. When institutional investors redeem their large investments, it could move prices and hurt smaller retail investors.

Some critics point out that few UCITS hedge funds are larger than $25 million.

Critics also point out that UCITS III hedge funds often underperform hedge funds because of higher fees. UCITS funds tend to have lower margins because of higher operating costs and distribution costs. Operational requirements are higher as daily net asset values are needed rather than monthly.

Eurekahedge statistics show traditional hedge funds outperformed UCITS III hedge funds over the past three years. This is because traditional hedge funds use leverage. Furthermore, event driven and distressed debt that performed well in 2009 are not largely represented in UCITS III funds.

Eurekahedge statistics also show that UCITS III hedge funds performed better than funds of funds.

Argument for UCITS III funds of funds
The argument for the UCITS fund of funds approach is that because there are so many alternative funds either in UCITS, or looking at UCITS, it is difficult to sort out the good from the bad. That makes a very strong case for the multi-advisor fund approach, adds Ballos. The fund of funds as the investment manager is responsible for manager selection, due diligence and asset allocation.

Dupuy adds that a UCITS fund of funds provides a great advantage over the traditional funds of funds. “We can truly act as best-of-breed multi-manager and turn our portfolio around very quickly; something that an offshore funds of funds could not do, having to give sometimes three months’ notice on a quarterly fund. This is valid also for institutional investors.”

“The liquidity and transparency offered by UCITS gives us a lot of flexibility in the way we can manage our portfolio. We can be more opportunistic than a traditional fund of funds would be,” adds Dupuy.

Dupuy points out that the UCITS fund allows the UCITS fund of funds manager and institutional investors the ability to closely monitor what the underlying manager does, the risk he is taking, identify where and why he is making or losing money and enables them to identify style drift, increased liquidity risk, concentration risk, etc.

Outlook
Despite the criticisms and caveats, many are very optimistic about the future of UCITS funds as well as funds of funds. The number of UCITS III funds is expected to skyrocket as tighter regulation of hedge funds occurs globally.

US managers are starting to jump aboard the UCITS trends as it is one way around EU law threatening to freeze US managers out of Europe. York Capital Management’s UCITS fund is up and running while Paulson & Co, Traxis and Peter Schoenfeld Asset Mgt are among those expected to start imminently.

Because EU law requires UCITS managers to be domiciled in the EU, some managers are taking the bank platform route with the likes of Bank of America Merrill Lynch, Deutsche Bank and Morgan Stanley.

“I am convinced that for some strategies, UCITS will replace traditional hedge funds,” Dupuy concludes.

The above is an excerpt from the current issue of Investor Focus which interviews:
• Thanos Ballos of Strategic Investments Group
• Omar Kodmani of the Permal Group
• Philippe Dupuy of Alternative Advisors and
• Chris Rule of Key Asset Management.

Other features include:
Sentiment Indicator: Investors
Overview of UCITS structures
UCITS Indices
Sampling of UCITS funds of funds
Sampling of UCITS platforms
Who’s Who in UCITs

The SEC is proposing that a family office be defined as a firm that:

• Provides investment advice only to family members, certain key employees, charities and trusts established by family members, charities and trusts set up by family members, and entities wholly owned and controlled by family members.

• Is wholly owned and controlled by family members

• Does not hold itself out to the public as an investment adviser.

Historically, family offices have not been required to register with the SEC under the Advisors Act because of an exemption provided to investment advisers with fewer than 15 clients. The Dodd-Frank Act removes that exemption, enabling the SEC to regulate hedge fund and other private fund advisers, but includes a new provision requiring the SEC to define family offices in order to exempt them from regulation under the Advisers Act.

Public comments on the proposed definition should be received by the SEC by November 18, 2010. The Dodd Frank Act becomes effective on July 21, 2011.

The SEC has been charged with adopting a definition that is consistent with the SEC interpretation in prior exemptive orders.

Because multi-family offices serve more than the lineal descendants of a single individual, multi- family offices with more than 15 clients are not expected to qualify for the “family office” exemption and are likely going to need to register as investment advisers with the SEC or their home state depending on the amount of assets under management. As SEC-registered investment advisers, multi-family offices will have to adhere to the same requirements as other investment managers, including, for example, the requirement to appoint a chief compliance officer and to have written compliance policies and procedures.

Industry observers estimate approximately 2500 to 3000 family offices exist in the US, managing in total over $1.2 trillion in assets. Generally, family offices have at least $100 million in investable assets.

Views on hedge funds
Family offices, which had scaled back their hedge fund investments during the financial crisis and who were angered by gates and frozen redemptions, are slowly investing again. In the aftermath of the Ponzi schemes and fraud cases, they have concerns about the safety of their assets and investment portfolios.

As a result, many family offices are reassessing their portfolio construction, asset allocation and risk management policies.

Based on the family office interviews in the current issue of Infovest21‘s Investor Focus, we see families are allocating a higher percentage of their portfolio to liquid assets and are accepting lower returns. Some are investing a higher percentage in gold.

Families are also spending more time doing thorough due diligence on topics such as liquidity, lock-ups, side pockets, fees and terms. Due diligence has become more sophisticated. Some conduct identity, background and reputational due diligence as well as operational due diligence. Manager’s controls, procedures and counterparty relationships are assessed. Some family offices have instituted on-site compliance efforts where they test and independently verify practices. Monitoring is occurring at regular intervals.

Some family offices are reexamining portfolio construction and emphasizing risk management. In particular, some are examining tail risk hedging.

The issues contains interviews with:
*RIJO Investments
*Consolidated Investment Group
*Nine Thirty Capital

Other features include:
*Family office and tail risk hedging
*Family office regulatory update
*Sampling of Who’s WHo in Family Offices
*Quarterly Sentiment Indicator: Managers

Christine Jurinich, partner and member of the investment committee at Offit Capital Advisors,points out “In 2008, there were some specific strategies or even an outlier of a manager in a specific style that preserved capital in 2008 through a combination of hedging, managing exposures tactically or security selection. We have found that there are talented hedge fund managers, some in Europe, for example, that were in strategies such as long/short equity, volatility or fixed income that just did a better job than funds in the tri-state area. We believe that some of these, as well as some funds in Asia, South America and Europe can diversify the return stream, although clearly in 2008 Asian exposurein particular had large losses and was very long biased. That being said, there are long/short equity funds that also were down slightly to positive in 2008 also outside the tri-state area that are off the radar, that diversify the return stream and don’t own APPL for example, which is what we are looking for.”

Another New York family office points out that they are focusing on Asia and emerging managers. “We are taking a broader view on where investment opportunities are and are not just focused in the US.”

Another reason for looking abroad is that some US families feel vulnerable to the US dollar and dollar returns. “US based investors are concerned about the US dollar as a store of value, even with positive nominal returns, value of these dollars could erode over time. So non-dollar investments offer the opportunities for real gains that are derived from the currency and the underlying asset exposure,” observes Jurinich.

Anthony Gordon of the Gordon Family Office says he is looking for a healthy dose (20-30%) of multi-currency cash allocations in the Group of 10 and emerging markets. “Investing across borders is the way to go today.” He is keen on Brazil, Russia, India and China and other countries who supply the large economies of Korea, Mexico, Indonesia, Nigeria, South Africa, Vietnam and Australia. Not only because of their “higher potential growth but also the assessment of the sheer amount of work currently required to restore confidence in the US financial and political system.”

He adds that quantitative easing by the Federal Reserve may do little to spur consumer demand unless unemployment and poverty is reduced.

Excerpts from
Infovest21‘s September Investor Focus.

Investors should look at the seeder’s experience – that is the key factor, says Robert Discolo of PineBridge Investments. “You need people who’ve been doing this for a long time and during different cycles. They have to have a lot of relationships and experience. Due diligence of emerging managers is very different from due diligence on regular funds because you have limited data to work with.”

He says investors should also look at prior seeds’ experience and performance. Investors also need to look at the worse-case scenarios – how many problems and how many blow-ups have there been. Also look at risk controls the seeders have in place and how they monitor it.

Seeders provide their IRR which is a construct from the private equity world. It is an indicator of the investor’s economic return; it is based on cash flow. “…if a seeder gives money to a manager and then pulls it back after three or four years, the seeder still has a revenue share. The IRR can’t go down because there is no money at risk. The additional increases in IRR are based on the profit share for each individual manager,” adds Discolo.

Another veteran seeder suggests that other metrics be examined besides IRR such as gross return, net return, cumulative draw down, the amount of assets distributed, unrealized value and total value. Fee income is another important metric which reflects the manager’s ability to gather assets i.e. distributions relative to paid-in capital.

Institutions and seeding
Institutions are increasingly looking at seeding arrangements.
In the summer of 2010, Rock Creek won a mandate from New York State Common Retirement Fund to manage the first installment of the pension’s new emerging manager program. Rock Creek is playing a key role in developing the emerging manager hedge fund portfolio, focusing on newer firms, firms with assets totaling less than $500 million, and women- and minority-owned fund management companies.

At that time, the $132.6 billion pension fund has about $5 billion committed to emerging managers. Of that, about $2 billion was in private equities and $3 billion in public equities. The pension is now developing a similar program in its real estate portfolio.

Other pensions with emerging manager programs include New York City Retirement System, California State Teachers Retirement System and California Public Employees’ Retirement System.

As of September 30, 2010, CalPERS had $1.3 billion in its MDP programs, close to $600 million in the emerging manager funds of funds program (which is part of the external manager program via FIS and Leading Edge), about $539 million in the fund of emerging hedge fund program (which is part of the Risk Managed Absolute Returns Strategies program). In the latter program, CalPERS had about $143 million with PAAMCO’s fund of emerging funds, $201 million with Rock Creek fund of emerging funds and $194 million with 47 Degrees North.

CalPERS’ Performance – Emerging Manager Fund of Funds
FIS Group
Inception date: Feb 2008
AUM $M: $269
YTD Return(%):0.87
Last 1 Year Return(%): 2.08
Last 3 Year Return (%): N/A
Since Inception Return (%): -0.11

Leading Edge Investment Advisors

Inception Date: March 2008
AUM $M: $298
YTD Return (%): -0.63
Last 1 Year Return (%): 0.76
Last 3 Year Return (%): N/A
Since Inception Return (%): -0.70

Source: CalPERS Global Equity Program Review, Oct 18, 2010

Excerpt from just-released Infovest21 Investor Focus