Backing Talent, Not Track Records | Chief Investment Officer

The $3 billion Hartford HealthCare fund has seeded a series of niche plays at big-name asset management firms, CIO has learned, often as client #1 for untested teams.

A little over a year ago, Hartford conducted a traditional search—via consultant and requests for proposals—for a liquid natural resources vehicle, and nothing off-the-shelf appealed. The end result? Hartford wrote a $40 million check to a fund that didn’t yet exist: A relatively low-oil commodities blend out of establishment firm Cohen & Steers.

“If the right product doesn’t exist, we’ve got no qualms about backing the teams to actually deliver it.”“Everybody does natural resources by a cap-weighting, which makes most funds about 60% oil-based,” CIO David Holmgren said in an interview. “In my view, don’t take the benchmark as given. It’s a starting point, nothing more and nothing less.”

Cohen & Steers risk-balanced agriculture, metals, oil, and other commodities as its starting point, which “fundamentally aligned” with Hartford’s goals. The hospital endowment has since upped its total seed investment to $70 million, as Cohen & Steers prepares the year-old strategy for fundraising primetime.

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The extra legwork and risk relative to off-the-shelf investing didn’t phase Holmgren.

“We’ve felt it far more prudent, reliable, and successful to spend time making sure we’ve invested in the right people, whose investment beliefs align with how we think,” he explained. “And if the right product doesn’t exist, we’ve got no qualms about backing the teams to actually deliver it.”

A consumer-brand licensing play—“probably the weirdest investment in the portfolio,” according to Holmgren—came next. Once again, this untested strategy and team worked under the banner of a brand-name asset manager: Neuberger Berman.

Hartford committed $18 million last summer to Marquee Brands, then a six-month-old unit seeking to “identify, acquire, and manage high quality brands” across “all consumer segments,” according to Neuberger. Connecticut’s main medical center now owns stakes in clothier Ben Sherman and a luxury Italian stiletto brand, via Marquee acquisitions.

Three more early-stage opportunistic allocations have followed, all benefiting from the institutional-quality infrastructure of name-brand firms.

A litigation-finance vehicle from Halcyon Capital Management (total assets: $10 billion) earned $12 million from Hartford in January.

Holmgren’s office became the first investor in State Street Global Advisors’ global macro hedge fund roughly six months ago.

A Japanese equity startup out of Wellington took Hartford’s largest and latest seed investment at $50 million. While stressing that the initial months’ performance mean nothing in the long term, Holmgren noted that the fund was off to an extremely profitable start.

“So much of the institutional investment industry is designed around pursuing product continuation,” he said. “It’s not set up to seed talent. For us, at our size, this is a whole new strategy to win. It requires due diligence and evaluation based on merits and theses, not buckets and track-record comparables. But that’s what investing actually is, right?”

Lack of disclosure requirements might help hedge funds maintain a competitive advantage—but it also enables them to take more risks than investors can see.

“Transparent funds are more sensitive to past performance than secretive funds, consistent with investors having a more difficult time making inferences when signals are obscured.”Research has shown that by secretly loading up on risk factors, these non-transparent hedge funds are able to earn risk premia that help them outperform in good markets. However, these same hedge funds are also much more susceptible to market crashes due to the extra risk taken, according to a study by Ellington Management Group’s Sergiy Gorovyy and Patrick Kelly, and Olga Kuzmina of the New Economic School.

“While the greater secrecy afforded hedge funds allows them to pursue proprietary investment strategies with less risk that other investors might mimic and free ride on their strategies, there is a natural tension between secrecy and the ability of a hedge fund’s investors to monitor the managers, who in the absence of monitoring may deviate from strategies which are optimal for the investors,” they wrote.

By examining the performance, transparency, and asset flows of hedge funds held by funds-of-funds from 2006 to 2009, the researchers found that highly secretive hedge funds outperformed the most transparent funds by 4% to 9% per year during good economic environments.

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When the market turned, however, the secretive funds earned 7% to 17% less on average than transparent funds.

“Higher managerial skill or superior proprietary strategies of secretive funds on their own are not consistent with the observed pattern of performance,” the trio wrote. “Secretive funds may of course have a higher skill on top of taking more risk. However… the observed performance pattern during bad times is not consistent with being purely better market timers.”

While secretive hedge funds were more likely to crash than transparent funds, Gorovyy, Kelly, and Kuzmina found that investors were found to be more likely to exit transparent funds due to past performance.

“Transparent funds are more sensitive to past performance than secretive funds, consistent with investors having a more difficult time making inferences when signals are obscured,” they wrote.

Deprived of information, even the most “savvy and sophisticated” investors can be fooled into thinking they are paying for skill, when they’re really just getting risk premium, the trio argued.

“There may be a rationale for increasing disclosure requirements, so that investors understand what they are being compensated for when they receive their seemingly superior returns,” the researchers concluded.