The PAAMCO-Texas Connection

A new joint venture between the Employees Retirement System of Texas and the Pacific Alternative Asset Management Co. (PAAMCO) will seed emerging manager hedge funds as the Texas pension fund looks to grow its billion–dollar emerging manager program.

The program, known as PAAMCO Launchpad, will invest $3 billion into the start-up funds, opening them up to other large-scale institutions unwilling to be the first to invest. As the emerging funds garner stability, the program will rotate some of the managers out in favor of others that need more support.

The seeding platform takes a unique route due to its teaming with a public pension fund from the get-go to seed the emerging manager hedge funds. Larger institutions tend to show up later, when the hedge funds have already somewhat established themselves.

Andrew Gitlin, a hedge fund veteran known for his near 30 years of seeding work, is in charge. His first venture was in the early 1990s with hedge fund AIG Capital. It was there that he began seeding. Gitlin had initially started the process like a fund of funds, but over a year and a half in, it had become a full-blown seeding operation.

“I started slowly pulling the money back from the outside managers and just [started] bringing guys and folks in-house and seeding them,” he said.

Gitlin ran AIG’s seeding business for 10 years, leaving to form his own hedge fund for several years before departing leaving in 2007 to work for a merchant bank with the Dubai government.

He told CIO that although he had walked away from the seeding model in the early 2000s, the financial crisis’ “cleansing of managers” who “didn’t belong in the business,” and a clear–cut view of what the relationship between the seeder and the emerging manager looks like pulled him back in—and Texas with him.

At the time, Gitlin was working with Prime Allocation Group, a hedge fund advisory firm he founded when he met the folks from the Texas pension. The meeting sparked talks that would lure Gitlin back into the seeding world, launching the platform’s concept as well as who he’d like on the maiden voyage.

“… I developed a relationship with Texas and knew that it was something they were looking at but they were looking for the right way to express their interest in the business,” Gitlin said. “I didn’t see it as sort of a black box business where you just create one big fund and you just tell people to be LPs, tell institutions to be LPs, at least the large institutions.”

For the initiative, Texas became involved following talks with industry professionals on how to meet its emerging manager program’s 10% target, and bring in greater returns in the EM arena. Their program began about six years ago, but the plans to get involved with and help develop PAAMCO Launchpad formed last year.

“In our opinion, it was just a natural evolution of our existing [hedge fund] program,” said Panayiotis Lambropoulos, who leads the program on the Texas side. “We started asking ourselves the question on whether or not it was time to examine what constituted an emerging manager in terms of hedge fund terms and whether or not we were missing opportunities by not expanding our search universe, if you will.” After talks with industry professionals, seeding firms, and outside stakeholders on how to approach the idea, Texas stumbled upon Gitlin.

Sharmila Kassam, the retirement system’s deputy CIO, told CIO that the fund has been trying to avoid running smaller manager programs in a silo. “I think that’s been one of the practices in the industry, but actually integrate it in the asset classes, so it’s a more established part of our investment program,” she said, adding that the exposure achieves a diversified stream of returns that the $28 billion Texas pension system wouldn’t get from a larger manager.

This fall, Texas and PAAMCO Launchpad will be holding their first emerging manager hedge fund event at KKR’s office in New York City. KKR merged with PAAMCO last year to form PAAMCO Prisma Holdings.

The event, which takes place October 24–25, seeks to reel in talent for the program. At the gathering, Gitlin and company will chat about Launchpad’s mission, inviting 40 managers to come via an e-mail based vetting process. The chosen managers will be given 30 minutes to present their strategies and hedges to PAAMCO Launchpad and Texas officials. 

Managers interested in attending and pitching their organizations at the event must email ERS@paamcolaunchpad.com. 

The program is aimed at seeding emerging markets hedge funds. The field, while slowly gaining popularity, is not the first one would think of when launching a platform. Texas’ reasons are to boost its $1 billion emerging manager program, which fluctuates between its 9% and 10% target. Gitlin’s reasons for PAAMCO are a little more personal.

“I knew [PAAMCO founder] Jane Buchan for a long, long time,” he said.

Buchan was a client of Gitlin from his days at AIG, at the early days of his seeding career. Gitlin said she was “one of the smart people I used to talk to all the time,” and that Buchan used to invest in some of his strategies with several of Gitlin’s managers.

“I met him and invested with him at my prior place of employment back in the ‘90s…and he had identified a bunch of hedge fund managers,” Buchan said. “Instead of forming a multi-strat… they ran individual portfolios and we actually hired several of them. I think between the strength of our infrastructure and knowing me for so very long, that’s why he called me up.”

“That’s another reason it makes a lot of sense,” he said. “You know how the person operates, so that’s how we came together.

Throughout its 18-year lifespan, PAAMCO has worked with emerging managers, building its infrastructure around trade by trade oversight and risk analysis. Last year, the $30 billion hedge fund of funds merged with Prisma KKR to form PAAMCO Prisma Holdings, a majority employee-owned company that manages assets via its subsidiaries. Buchan is currently moving into an advisory role at her firm while working on a quantitative fund, which she’s looking to launch next year.

Another reason why Gitlin got involved with PAAMCO is for “trade by trade transparency and oversight,” largely because transparency has become more accepted since he manned the trading grounds.

“I want to be involved with a manager where my risk management oversight and trust isn’t based on a monthly NAV that I get from the manager, plus based on the fact that we’re seeing every trade and we’re able to validate what the manager’s doing… in my early days we didn’t do that,” he said. “We didn’t have the infrastructure for it. It wasn’t the norm, and the managers typically refused. But today it’s the only way we operate.”

Gitlin and his team will introduce the institutions to the emerging managers, which will lead to direct investment if all are in alignment. The institution, now with access to the manager in a cost–effective way, will not only see the profits from its multi-return source, but negotiate a better fee arrangement because, as Gitlin puts it, “they’re sort of seeding the manager. In addition, the institution will also get a cut of the manager’s revenue. “And sharing in that growth of the manager is where I think the institution starts getting closer to the source of returns and starts looking more sort of like a GP to an LP because they’re participating in the upside rather than taking the risk,” said Gitlin.

 The program’s chief selected several reasons why a hedge fund manager’s earliest years tend to be their best, establishing his intentions for choosing emerging managers. The first is size and agility. Another is the newer manager’s focus to establish itself before it gets too large. Gitlin says they are “more likely to be purely focused on the markets as opposed to running a large business.” Gitlin said there are academic reasons for getting involved in emerging managers and the hedge fund space, “but when you add on the additional two components of getting a revenue share from the manager’s growth and the fee arrangement, it becomes very compelling from a total return perspective.”

Gitlin says what it really comes down to is the Catch–22 of large institutional investors’ unwillingness to be the first to invest in smaller managers, even if the markets and timing are right. With the development of a seeding platform to form the bedrock of these managers, larger investors will start to dip their toes in the water, creating a snowball effect. “And then the other institutions can come along in after that,” he said. “You get paid for that, and that makes a lot of sense.”