Although it is not unusual these days for a pension fund to dump its fund-of-funds managers and invest directly in hedge funds, it’s less common for another pension fund to scoop up those same assets for its own portfolio.
But that’s exactly what is happening at the $49 billion Massachusetts Pension Reserves Investment Management Board, which is cashing out of four of the five fund-of-funds managers it now invests with to go directly into hedge funds. And the $69.4 billion New Jersey Division of Investment, which oversees investments for the state’s public workers, is picking up some of those investments. It’s a novel move for a pension fund and is somewhat reminiscent of what happens in hedge fund secondary market trading, when investors trade investments in hedge funds directly with each other rather than redeeming from the manager. In these instances, investors sometimes sell their holdings at a discount or premium to what they originally paid. (The secondary market for hedge fund investors gained traction after 2008, when many investors were stuck with hedge fund holdings they could not redeem, either because they were illiquid or because managers had locked up their capital. Sellers were able to offload those investments in the secondary market; buyers picked up assets on the cheap from liquidity-starved investors.)
The New Jersey/MassPRIM deal is different in that MassPRIM is playing a less active role. The fund-of-funds managers are acting as intermediaries in the deal, working with New Jersey to help the pension gain access to managers in MassPRIM’s fund-of-funds portfolio. New Jersey is already invested in two of the managers from which MassPRIM is redeeming — New York–based fund-of-funds firm Arden Asset Management and Washington, D.C.–based fund-of-funds manager Rock Creek Group — but because those firms run different customized portfolios for both pensions, its portfolio does not contain some of the managers MassPRIM invested in. The deal will allow New Jersey to access some of those managers. Walsh says the division will also have the ability to customize its investments with both fund-of-fund managers to make sure they don’t overlap with its direct portfolio.
To be clear, New Jersey is not scooping up these funds at a discount, as Michael Trotsky, executive director at MassPRIM, says he would only give away his hedge fund stakes at net asset value. Still, New Jersey will be getting a good deal, as its fund-of-funds managers will be negotiating more fee cuts with the managers that New Jersey might acquire.
Although it may seem easier for the New Jersey pension to just mimic the MassPRIM portfolio, Tim Walsh, director of the Division of Investment for New Jersey, says there are benefits to working directly with MassPRIM — and other pensions who may be willing to offload their fund-of-funds investments. Walsh, whose pension fund is underweight macro hedge funds, is particularly interested in picking up macro managers from MassPRIM that might otherwise be closed to new money. He also explains that the pension, given its size, tends to write big tickets to the larger managers, whereas in this case, it might want to pick up some smaller niche managers, via MassPRIM’s investments in Arden and Rock Creek, that could only take in smaller amounts of money.
Steve Nesbitt, CEO of consulting firm Cliffwater, which advises both MassPRIM and New Jersey on their hedge fund investments, adds that while this deal would give New Jersey the opportunity to place money with successful macro managers that are closed to new money, it benefits MassPRIM as well, since the pension can unload its stakes faster than usual.
The division recently opted to invest an additional $250 million in Rock Creek’s RC Woodley Park and $500 million in Arden Institutional Advisors, in part for the purpose of picking up hedge fund stakes from MassPRIM. New Jersey invests in hedge funds both directly and via funds-of-funds and has a 15 percent cap on how much it can invest in hedge funds (it is about 8 percent invested so far).
As many other pensions continue to unwind their investments in funds-of-funds, Walsh thinks some other gems could be found in these portfolios and is considering looking at more investments that other pensions are unloading. Although there is no evidence of other pensions taking part in this unique play yet, Walsh thinks other investors might also take this route as another option for finding quality hedge fund managers.
New Jersey is getting discounts via its funds-of-funds fees, where Arden and Rock Creek have both offered low management fees and will be working to negotiate lower fees with the underlying managers as well. According to fund documents, Arden is charging a 0.22 percent management fee on new capital, which averages out to a 0.19 percent blended fee on all of its capital. Rock Creek is charging a 0.20 percent management fee. These are both far lower than the traditional 1 percent management fee that funds-of-funds typically used to charge.
Neither executives for New Jersey nor those at MassPRIM would comment on which managers New Jersey might be looking to pick up. A spokesman for Arden declined to comment; calls to Rock Creek were not returned.
For its part, MassPRIM is just starting to unwind its fund-of-funds stakes and is ultimately planning to invest most of its money directly in hedge funds. The pension is also terminating its investments in fund-of-funds firms K2 Advisors and Grosvenor Capital Management, while Pacific Alternative Asset Management is the only fund-of-funds that will remain on board. MassPRIM plans to invest 10 percent of its portfolio in hedge funds, with 85 percent of those assets going directly to 20 to 30 managers and the other 15 percent being managed by Paamco.
