Texas (STOTX1)’s Permanent School Fund may hire in-house money managers to oversee its $25 billion in assets because returns are being “eaten alive” by hedge-fund fees, according to Chief Investment Officer Holland Timmins.
Returns were less than 1 percent for the 44 months through November on assets managed by the five companies that bundle multiple hedge funds into single investment vehicles, Timmins said Jan. 25 at a State Education Board meeting. After fees, the return was negative, he said.
“The sector that should have enhanced our funding for schools actually detracted from it,” Timmins said. “We had a positive return in the asset class, modestly, but it got eaten alive by the fees.”
Hedge-fund expenses have reached about $72.7 million since 2008, according to a document Timmins distributed among board members. The reserve backs school-district debt and distributes $1 billion annually to support public education in the second- biggest U.S. state by population. The board voted 13-0 today to draw up a detailed plan for making the change, said Tom Ratliff, a member of the board’s investment committee.
Driven by Competition
“Big-brand hedge funds have been able to maintain their fee levels, but other funds have had to react to the marketplace and make adjustments,” said Brian Bruce, a former finance instructor at Southern Methodist University who previously worked for PanAgora Asset Management Inc. in Boston. “But that’s been more driven by competition rather than people saying these fees are too high.”
The Standard & Poor’s 500 Index of equities gained 2.3 percent including reinvested dividends from March 31, 2008, through November 30, 2011. The reserve’s hedge funds had a gain of 0.75 percent through that month, according to Timmins.
Timmins proposed hiring one of the current investment managers to advise on allocating assets to hedge funds, while one or more of the poorly performing companies would be dropped. The adviser would be picked from among the five firms, according to Patricia Hardy, the head of the board’s finance committee.
Picking the adviser from among the current providers would save time, as they are familiar to the board and know the reserve’s investment goals, board members said.
About 68 percent of the reserve’s costs, or about $34 million a year, is tied to absolute-return and private-equity investments that hold just 16 percent of its assets, Timmins said at a July meeting. Absolute-return fees are projected to be $114.7 million from 2012 to 2016 under the current system, excluding private-equity investment costs, he said.
The fund had $2.42 billion in hedge-fund assets as of Aug. 31, 2010, according to its annual report.
The proposed arrangement would deliver the same strategic advice provided by outside companies at a lower cost, said Ratliff. “They will still be making plenty of money,” he said of the hedge fund companies.
The Legislature last year added $18 million annually to the fund for new employees to manage assets and cut costs, Ratliff said. The board hasn’t acted in deference to Texas Education Agency Commissioner Robert Scott, who is hiring a deputy commissioner to focus on the fund, he said.
The five companies that oversee the reserve’s hedge-fund investments are K2 Advisors LLC, Grosvenor Capital Management Holdings LLP, Mesirow Advanced Strategies Inc., Blackstone Alternative Asset Management and GAM Holding AG (GAM), according to documents distributed in July. The fund dismissed Goldman Sachs Group Inc. (GS) last year, citing performance issues.
Timmins didn’t say how many new employees would be hired if his proposal is set in motion. In July, he estimated about 30 would be added.
Christine Anderson, a Blackstone Group LP (BX) spokeswoman, and William Douglass III, a K2 co-founder, didn’t immediately respond to telephone calls seeking comment on the proposal. Bill Blase, a spokesman for GAM, declined to comment. Officials of Mesirow and Grosvenor didn’t immediately respond to telephone calls or e-mails.
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