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Colorado Foundation’s Faith in Hedge Funds Unshaken Market Rout

Date: Friday, March 6, 2009
Author: Katherine Burton, Bloomberg

Christopher Bittman, head of the $1 billion University of Colorado Foundation, is committing more money to hedge funds even after the industry handed investors record losses last year.

Bittman plans to add as much as $30 million to the private partnerships in 2009, lifting the foundation’s hedge-fund holdings to about 20 percent of assets because he expects them to hold up better than other investments in the global bear market.

While Morgan Stanley estimates that clients may withdraw 20 percent of the $1.2 trillion they have in hedge funds this year, not everyone is running for the exits. Investors like Bittman are adding to their positions, focusing on funds that hold easy-to- trade assets like stocks and currencies. Others are adjusting their portfolios or changing managers to better survive.

“Institutional investors are by no means through with hedge funds,” said David Holmes, a partner at Eager, Davis & Holmes, which tracks the hiring of money managers. “But it will be a bit slow for several quarters as investors rethink their investment goals and strategies.”

Investors are adding new managers this year at about the same pace as they did in the fourth quarter, when nine institutions placed $582 million with hedge funds, according to the Louisville, Kentucky-based research firm. In the fourth quarter of 2007, 28 institutions invested $1 billion.

Bittman’s foundation, in Denver, returned an average of 10 percent in the five years ended Sept. 30, twice the gain of the Standard & Poor’s 500 Index. He expects stock hedge funds to be among the best performers this year. He’s also considering a macro fund, a category in which managers chase macroeconomic trends by betting on stocks, bonds, currencies and commodities.

Focus on Liquidity

“We appear to be past the panicked, indiscriminate selling of the fall,” said Bittman, 45, whose foundation has money with six hedge-fund managers. While stocks may drop more, “people are stopping short of throwing the baby out with the bathwater. And last fall that wasn’t the case.”

Huw van Steenis, a Morgan Stanley hedge-fund analyst in London, says most inflows this year will go to the strategies that are the easiest to trade, or most liquid, including stock funds, macro funds and commodity trading advisers, who bet on market trends using futures. Investors are eschewing any strategy that locks up their cash or relies on borrowed money to amplify returns.

“Long-short equity is at the top of the list,” said Stewart Massey, founder of Morristown, New Jersey-based Massey Quick & Co., which advises wealthy individuals, endowments and foundations on investments. Long-short managers bet on stocks they expect to rise as well as shares they think will tumble.

Return to Fundamentals

“There will be terrific bargains on the long side, and because we are in a difficult economy there will be great shorts out there too,” he said.

Depending on the client, Massey is recommending a 50 percent allocation to equity hedge funds, a percentage he expects to increase this year.

Hedge funds tumbled 19 percent on average in 2008, the worst year on record and only the second time the industry has posted an annual loss, according to Chicago-based Hedge Fund Research Inc., which began tracking returns in 1990. Clients pulled about $250 billion from hedge funds last year, a number that would have been higher if not for the record number of funds that limited withdrawals.

Most hedge funds must recoup last year’s losses before they can resume collecting fees on investment gains, usually a cut of 20 percent. Managers also typically take a fee equal to 2 percent of client assets under management.

Ray of Light

Against this dismal backdrop, hedge funds have started making money again, with average performance up 0.38 percent through March 3, according to a daily index published by Hedge Fund Research.

One reason is that opportunities to pick winning stocks have increased. In 2008, 24 stocks in the Standard & Poor’s 500 Index rose as the market plunged 38 percent. This year, 45 stocks have gained ground even with the benchmark index down 24 percent.

Doug Douglass, co-founder of K2 Advisors LLC, a Stamford, Connecticut-based firm that invests $6 billion in hedge funds, is steering $350 million to stock funds this year as part of a mandate from Highland Good Steward Management LLC, based in Birmingham, Alabama.

Good and Bad

“There is a wide dispersion of good and bad companies out there,” he said.

While equity hedge funds have dropped 2.5 percent on average this year, according to Hedge Fund Research, the biggest funds have gained. William von Mueffling’s Cantillon World Ltd. is up 7.6 percent through Feb. 28. Andreas Halvorsen’s Viking Global Equities III has jumped 8.2 percent and Dan Loeb’s Third Point Offshore climbed 1.6 percent.

Macro funds have risen 2.3 percent in 2009, profiting from strong trends including a strengthening dollar, falling oil prices and tumbling stocks indexes globally.

“In macro markets, it’s a trader’s paradise,” said Omar Kodmani, senior executive officer of New York-based Permal Group, a unit of Legg Mason Inc. that invests about $23 billion with hedge funds. “There have been very strong moves on a day-to-day basis in all the major markets.”

Veteran macro mangers have done better than the index, with funds run by Paul Tudor Jones and Bruce Kovner climbing about 4.5 percent through the end of February.

To contact the reporter on this story: Katherine Burton in New York at kburton@bloomberg.net