WSJ (01/02/01, R8): "Interest in [HF] Builds As Managers Begin to Scale Back"
January 2, 2001
Year-End Review of Markets and Finance
Interest in Hedge Funds Builds
As Managers Begin to Scale Back
Investors, weary with stock markets, seek outlets for diversification
By IANTHE JEANNE DUGAN
Staff Reporter of THE WALL STREET JOURNAL
When California Public Employees' Retirement System decided in November to devote $1 billion to hedge-fund investments, its executives expected managers of these lightly regulated investment pools to line up at its door. "We're a big name and a choice long-term investor," says Mark Anson, Calpers' senior investment officer for global equity.
Instead, the country's biggest pension fund is the one doing the wooing. Turned away by several top managers, Calpers is seeking a "strategic partner" with contacts to "build relationships" with hedge funds. It expects to take two years to invest the money -- less than 1% of its $170 billion in assets.
That is the way it was for investors seeking to get into hedge funds as 2000 drew to a close. With new marketing armies pulling back the curtain on gains that can outshine the overall stock market, hedge funds -- investment vehicles designed for the wealthy -- have been mobbed with mainstream money. But at the same time, top fund managers -- rattled by departures from the business of giants George Soros and Julian Robertson -- are limiting their size in an attempt to buoy returns.
"The shakeout by the big guys cemented it in managers' minds that you could screw it up by getting big," says Bruce Ruehl, chief investment strategist at Tremont Advisers Inc., adding, "If you can make 30% with $500 million, you're not going to risk making 18% with $1 billion."
That strategy seems to be paying off. After being clobbered by technology losses, hedge funds eked out an average gain of 2.1% for the year 2000 through November, the most recent data available from the Credit Suisse First Boston/Tremont Hedge Fund Index. By comparison, the Dow Jones Industrial Average dropped 9.42% and the Standard & Poor's 500-stock index slid 10.5% during the same period. Year-end data for hedge funds won't be available until later this month.
Market-weary investors have come running. "People are realizing that it's not going to be a bull market forever and are literally looking for alternative ways to invest," says Jeffrey Izenman, chairman of the Managed Funds Association, a trade group.
During the third quarter of last year alone, about $4.2 billion poured into hedge funds, according to TASS, the research arm of Tremont Advisers Inc., a hedge-fund consultant. That erased panic outflows between April and June. About 83% of the new money in the third quarter was earmarked for "long-short equity funds," which essentially bet on both directions of the market. Investors meanwhile yanked $1.4 billion out of the sector over which Mr. Soros once reigned -- global macro funds, which bet on global currency movements.
Interest in hedge funds is only expected to increase. Virginia Parker, an adviser to hedge-fund investors in Stamford, Conn., predicts individuals and institutions will allocate more than $100 billion for hedge-fund investments this year.
Morgan Stanley Dean Witter concludes in a new study called "Why Hedge Funds Make Sense," that hedge-fund gains during the past 10 years rivaled those of mutual funds. Also, performance of hedge funds typically has a low correlation with traditional market benchmarks, indicating that hedge funds provide diversification in a volatile market.
"There has been tremendous interest from institutional clients in hedge funds," says Michael S. Urias, principal of quantitative strategies and a co-author of the report.
But whether the funds can accommodate such an inflow is another story. "One of the issues that has been raised," Mr. Urias says, "is capacity."
The squeeze is counterintuitive given the explosion in the number of funds. Ten years ago, there were a few hundred hedge funds that served as secretive preserves of the wealthy. Now, there are more than 3,000, managing an estimated $350 billion to $400 billion, according to TASS.
But money has been flowing in so fast that managers are capping their funds -- or getting out altogether. Star Boston trader Jeffrey Vinik thrust $4.2 billion back at his investors in October, shutting down his fund to focus instead on growing the mounds of money he earned managing other people's money.
"There have never been so many people starting funds faster with more money and closing quickly," says Robert S. Sloan, a managing director of derivatives at Credit Suisse First Boston.
In 1993, all but 5% of hedge-fund capital came from individual investors, says Ryan Tagal, senior analyst at Cerulli Associates Inc., a Boston mutual-fund consultant. Now, institutions account for 25% -- but most of it is from endowments and foundations, which have been investing in hedge funds for years and commit 10% to 20% of their assets to these pools.
Defined-contribution pension plans are coming late to the party. Cerulli estimates pensions control $5 trillion in assets for governments, states and corporations -- and they are willing to sink as much as 3% to 5% into alternative investments, such as hedge funds. Because they are big, pensions are used to calling the shots. At mutual funds, for example, they routinely negotiate cut-rate fees -- well below the 1.5% of assets mutual funds typically charge per year.
Hedge funds generally charge 1% of assets plus 20% of profits as fees. And they aren't motivated to cut them -- particularly for a higher-maintenance client. Pensions typically require more transparency and personal attention. Calpers, for example, will require the five to 10 hedge funds into which it invests to report performance to InvestorForce, an Internet database in which it recently took a stake.
"These [funds] have a waiting list of people who will not demand daily transparency and will pay full fees," Mr. Ruehl says. "Why should they cut fees and do more work?"
Sykes Wilford, chief investment officer at CDC Investment Management, says "a dream name that everyone wants" recently approached him with $150 million for a fixed-income program. "I told them this wasn't good business for us," he says. "They couldn't believe we didn't want to do it."
Giant investors may get some relief from mutual funds that are opening hedge funds. Many also are resorting to managers of managers.
Calpers is open to all of the above, to wedge a bit more into a tantalizing area. In 1999, Calpers invested $300 million in Pivotal Partners Fund, which focuses on technology investments. In February 2000, it placed about $100 million with Abacus Fund. The profits have been "wonderful," Mr. Anson asserts. How wonderful? "Up -- by slightly above 0%."
Write to Ianthe Jeanne Dugan at ianthe.dugan@wsj.com2
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