Pension funds, endowments and foundations are rethinking how they employ long/short equity strategies within their actively managed equity portfolios.
The mind shift is occurring as a growing number of fund executives are making their active equity portfolios more opportunistic, relaxing money manager constraints and allowing them to generate alpha where they can.
“Taking an opportunistic approach in an active equity portfolio means you can include more managers than you could before in the traditional equity bucket. It opens up a lot more discrete sources of alpha, widens the universe of managers you can look at. And because long/short managers do have some beta exposure, it frees up room within your absolute-return bucket for pure alpha managers,” said Alan H. Dorsey, managing director and alternative investment strategist at Lehman Brothers Inc., New York.
Relaxed constraint active equity approaches — including all-cap, 130/30 and long/short — have been used by pension funds for some time. What’s new is putting long/short equity managers alongside or replacing some long-only managers within a traditional long-only equity portfolio, said Janine Baldridge, director of U.S. consulting, Russell Investment Group, Tacoma, Wash.
“Endowments and foundations have been making a more explicit shift of active long-only active equity assets into long/short strategies, but it’s something that many pension investors also are thinking about.” Ms. Baldridge said. But the nascent trend is somewhat hard to track, she added. Some investors don’t classify hedge funds as a separate asset class and simply add the long/short equity managers into the “regular” active equity roster, while others count long/short equity within a separate hedge fund allocation.
“Institutional investors and consultants all are thinking about active equity management and how to structure a portfolio using a range of less constrained approaches,” said David Hammerstein, principal and chief strategist at consultant Yanni Partners Inc., Pittsburgh. “The fundamental question in constructing these portfolios is how much market exposure you want and how much flexibility you want to give to the manager,” he said.
Mr. Hammerstein noted that while there still is a lot of talk by pension funds about using less constrained managers, like long/short equity managers, within an active equity portfolio, only a few plans have taken action.
Endowment and foundation officials, on the other hand, have been moving long/short equity managers over to their traditional spaces a little more quickly, said Stephen L. Nesbitt, chief executive officer of alternatives consultant Cliffwater LLC, Marina Del Rey, Calif.
“We’re seeing a little bit of creep into the long-only space by endowments. They’ve moved long/short equity managers into their equity portfolios because their traditional active equity managers haven’t done well,” Mr. Nesbitt said. He declined to name the Cliffwater endowment and foundation clients who have made the move, but said “the good ones, the more sophisticated funds have done this,” he said.
Pension action
The $112 billion Teacher Retirement System of Texas, Austin, is rumored to be considering a plan to include long/short equity managers within the traditional equity allocation. The teachers’ plan has begun implementing a multiyear plan to increase the plan’s allocation to alternative investments to 29% of plan assets from about 5% (Pensions & Investments, Aug. 20). Howard Goldman, a spokesman for the Texas fund, did not respond to e-mailrequests for confirmation of the move into long/short equity.
In December, the $2.7 billion Cincinnati Retirement System will select two of four hedge fund-of-funds finalists to manage $65 million each in long/short equity strategies that will be considered part of the plan’s traditional equity allocation, said John Boudinot, executive director.
Like a number of investors, Mr. Boudinot said he doesn’t think of long/short equity managers as hedge fund managers because many long/short equity strategies are based on fundamental, bottom-up stock selection.
He said the idea of using long/short equity managers is appealing because it permits managers to “use the information that they have — wherever it takes them — to enhance returns. Because they are finding alpha in different places than traditional managers, it reduces the risk and volatility of the portfolio.”
Long/short equity managers not only can buy the stocks they like, they also can protect the portfolio by shorting the stocks they don’t like. And unlike 130/30 strategies that place much more stringent investment limits on managers so the portfolio always has 100% exposure to the market with a beta of 1.0.
Jeffrey Geller, chief investment officer of the global multiasset group in the Americas at JPMorgan Asset Management, New York, said, “The real question is whether you think you can find (long/short equity) managers who can add value over your other ‘beta one’ managers. If you can and you do add managers like this, it changes the complexion of your equity portfolio.
“The value added from long/short equity management is from the stock selection. It’s essential,” Mr. Geller said.
Concerns over high fees
Long/short equity approaches usually are managed in hedge-fund vehicles that typically charge a 1.5% to 2% management fee and a 10% to 20% cut of profits above a high-water mark. Those fees are significantly higher than the 30 to 50 basis point fee typically charged for managing a large, institutional active domestic equity portfolio, sources said.
The trick to making good use of long/short equity hedge fund strategies within an opportunistic active equity portfolio is finding managers whose “incremental performance is worth the higher price tag,” said Yanni’s Mr. Hammerstein.
One way around high hedge fund-type fees is to get long/short equity exposure from traditional managers. For example, Vanguard Group Inc., Malvern, Pa., is creating its first long/short equity mutual fund.
Pending shareholder approval, Vanguard is reorganizing the $21 million Laudus Rosenberg U.S. Large/Mid Capitalization Long/
Short Equity Fund that now is offered to institutional investors by Charles Schwab Investment Management Inc., San Francisco (P&I Daily, Aug. 23). The current subadviser, AXA Rosenberg Investment Management LLC, Orinda, Calif., will remain the fund’s primary manager, while the Vanguard Quantitative Equity Group also will begin to manage a portion of the assets. The fund will still be distributed through Schwab, but won’t be part of the Schwab fund family.
As part of making the fund more attractive to institutional investors, Vanguard will reduce net fees to 0.75% for investor shares and 0.6% for institutional shares, said Paul Bosse, principal and head of Vanguard’s asset allocation solutions group. The fund’s current expense ratios are 1.54% and 1.24%. The average expense ratio for long/short funds tracked by Morningstar Inc., Chicago, is 1.97%.
The impetus behind offering a long/short equity fund was entirely driven by institutional investors, Mr. Bosse said. “Investors have asked us over and over to consider offering a long/short equity fund and we finally gave in,” he said, noting that the fund will initially be targeted at endowments and foundations.
