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High-flying hedge funds draw billions from pensions

Updated 10:00 AM ET January 28, 2000
By Apu Sikri

MIAMI (Reuters) - A little more than a year after the near collapse of Long-Term Capital Management (LTCM) gave hedge funds a black eye, traditionally cautious public pension funds and university endowments are pouring billions of dollars into hedge funds and other alternative investments.

Hedge funds, unregulated investment pools that have been known to use secretive, risky strategies in hopes of generating stellar returns, drew government scrutiny after high-flying LTCM nearly went broke in 1998.

But many institutional investors at a conference here said hedge funds are a smart way to diversify portfolios that have earned big returns on U.S. stocks. Money managers are also guarding against a stock downturn by investing with other non-traditional vehicles such as venture capital partners and Real Estate Investment Trusts.

"The acceptance of alternative investments among institutions is growing geometrically," said Madhav Misra, managing director at Citibank Alternative Investment Strategies, a Citigroup unit.

"People have made so much money from equities in the last few years, they want some portfolio diversification. They see their colleagues doing it. They are getting comfortable with the strategy," Misra said.

About 28 percent of the University of Tennessee's endowment funds are invested in "alternative investments," university treasurer Charles Peccolo said, adding that about 10 percent of those are with hedge funds.

"We started investing with hedge funds last year. We think it's a nice way to diversify the portfolio," Peccolo told Reuters Thursday on the sidelines of a conference on alternative investments organized by the Institute for International Research.

In a landmark event, the California Public Employees Retirement System (Calpers), the largest U.S. public pension fund, said last year it would invest up to 7 percent of more than $160 billion in assets in alternative investments.

Such large infusions of new money have turned the hedge fund industry into a $310 billion business, experts said, changing the complexion of the industry.

Only two months ago, on Nov. 19, 1999, Congressional investigators said more must be done to head off a repeat of the near-collapse of LTCM a year earlier. The debacle threatened to seriously disrupt global financial markets, and the New York Federal Reserve ultimately engineered an 11th-hour rescue by several major international banks that were in danger of watching LTCM default on billions they had loaned it.

But money managers said such spectacular and well-publicized hedge fund debacles are an aberration. The near-demise of LTCM meant that "we have to educate our board (of trustees)," Peccolo said.

While LTCM made reckless bets, leveraging its own funds with billions of borrowed dollars, money managers said most hedge funds make small, hedged investments in niche markets where their managers have expertise. They often provide superior returns on a risk-adjusted basis and offer a safe haven if hot stock markets take a dive, money managers said.

"The returns from alternative investors can be double digit, often twice that of the market," said Walter Davis, a trustee for the Houston Municipal Employees' Retirement System. He has about 15 percent of $1.5 billion in assets allocated to alternative investments, including hedge funds.

Investors said hedge funds with so-called "market-neutral strategies are currently among the most popular. These funds seek to make money whether stock prices rise or fall, by buying and selling stocks in the same sector to take advantage of the differential in the price of two securities due to temporary factors. Many money managers said such funds provide a nice hedge in the current bull market, where worries are growing about high valuations of U.S. stocks.

"Certainly, the market-neutral funds are the most popular right now," said Citigroup's Misra.

Portfolio managers said select hedge funds with care. "We will not invest with a (hedge fund) manager unless we visit them and see the back office, said William Leavitt of Leavitt Capital Management. "It is as important to us as the intelligence and strategy of the manager."

Highlighting the importance of back office systems were problems last week at the Manhattan Investment Fund run by Michael Berger. Bank Austria AG, an investor, sued Manhattan Investment, alleging it falsified documents to hide large losses from losing bets against high-flying technology stocks.

Even after a long vetting process, pension fund managers say a desirable hedge fund can be hard to get into because of limits on the amount of capital many hedge funds will manage.

The caps are there because arbitrage and other strategies they exploit can absorb only so much cash. Staying relatively small helps hedge fund managers move nimbly in and out of positions without drawing undue attention in the markets.

While a few large hedge funds run by stars such as Quantum fund guru George Soros and Tiger Management chief Julian Robertson manage multibillion-dollar portfolios, most hedge funds manage between $200 million and $2 billion. The industry is grappling with the problem of how to handle the inflows from large public pension funds and university endowments.

"I've seen hedge funds close even before they are open. They get $300 million from Calpers and they are closed," said Robert Albietz, a money manager with Interland Corp., an investment management firm which gives money to hedge funds on behalf of institutional and other clients.

Fund Managers Too Smart For Their Own Good!

-- Teague Harper (tharper@cyberhighway.net), February 02, 2000

Answers

Generally, there are annual reports that inform people how their money is being invested. So it is up to the individual to inform the pension fund manager that they do not appreciate the way the funds are being invested. Blind faith is not compatible with financial matters.

-- Gia (laureltree7@hotmail.com), February 02, 2000.