Texas Lawmakers See Light on Hedge Fund Investments

(March 16, 2011) — In an effort to reduce the risk of volatility, the $108 billion Teacher Retirement System (TRS) may double its allocation to hedge funds under a bill from Representative John Otto.  

Under the bill, the pension could put up to 10% of its assets into the asset class. In 2007, the Legislature capped the allocation at 5%. “Notwithstanding any provision…not more than 10% of the value of the total investment portfolio of the retirement system may be invested in hedge funds,” the Act notes, asserting that the provisions would take effect immediately if it receives a vote of two-thirds of all the members elected to each house.

“The global financial crisis has been a great stress test,” the fund’s chief investment officer Britt Harris told aiCIO in August, describing the volatility that rocked the fund. The system’s assets peaked at $112 billion in 2007 and fell to less than $80 billion by early 2009. Since then, its assets rebounded to roughly $108 billion. Hedge-fund investments totaled $3.9 billion on June 30 compared with $1.2 billion five years earlier.

The Texas fund has relied increasingly on external managers since the state allowed it to hire external expertise to oversee up to 30% of its assets in 2007. “We manage approximately 60% of assets ourselves, with our strong history of internal management,” Harris said. “The legislature recently allowed us to allocate more than 30% to external managers, which has allowed us to add value to other managers we oversee around the world, particularly in emerging markets…our allocation to hedge funds has increased from 2% to 5%, and this allocation will be reviewed again in the next legislative session.”

TRS’ decision to increase its allocation to hedge funds follows the $84 billion State of Wisconsin Investment Board’s (SWIB) recent decision to make its first-ever allocation to hedge funds last month. The fund is allocating $100 million to Capula Investment Management LLP, reflecting the increasing attractiveness of hedge funds among institutional investors, supported by a recent report from Preqin that revealed institutional investors now constitute the largest piece of the hedge fund capital pie.

In an attempt to further diversity its assets, New York City’s roughly $23 billion Police Pension Fund, with a funding ratio of about 60%, also approved its first hedge fund investment this month, according to John Liu, the city’s comptroller.

A recent survey by Preqin confirms the increasing popularity of hedge fund investments among pensions. According to the study, the number of public pension funds allocating to the asset class has increased by 50% since 2007, with average allocation levels also rising significantly. “Public pension funds are one of the most influential groups of investors, and their increased uptake of hedge funds is shaping the new institutional era of hedge fund management,” Amy Bensted, Preqin’s manager of hedge fund data, stated in a release on the study. “Pension funds have realistic return expectations, and as they gain more experience of the asset class, there has been a fundamental shift in these investors towards allocating to hedge funds for capital preservation and portfolio diversification.”