Institutional Investor's Alpha Magazine - February 2009 - (Page 11)

CLASSREVIEW Convertible Backﬁre onvertible arbitrage strategies fell 35.83 percent in the ﬁrst 11 months of last year, twice the decline of the average hedge fund and barely better than the Standard & Poor’s 500 index’s 38.08 percent drop. Despite enormous challenges — the credit crisis, the inability to short certain equities, investor redemptions — convertible arbitrage managers who held their high-quality bonds through the September and October sell-offs looked good in November. Convertible arbitrage managers exploit pricing discrepancies between a company’s convertible bonds and its stock. C “We concentrated our book in what we viewed as the cream of the crop,” says David Van Blerkom, marketing director for $650 million Manhattan Beach, California–based Inﬂective Asset Management. The firm’s $130 million offshore Inflective Convertible Opportunity Fund I returned 7.65 percent in November, helped by its position in drug and medical-device maker Allergan. Recent declines in the value of convertible securities have created an opportunity, says Shawn Bergerson, founder and portfolio manager of $800 million Waterstone Capital Management, based in Plymouth, Minnesota. Its sole fund, Water- stone Market Neutral Master Fund, was up 3.08 percent in November. “To drive returns,” Bergerson says, “we bought more of the highquality names that were a potential catalyst in the near term.” Buying convertible bonds in Countrywide Financial Corp. and shorting those of Citigroup also helped. — Frances Denmark Fixed-Income Convertible Arbitrage Return November 2008 –2.91% –2.26 –7.18 January through November –35.83% –18.05 –38.08 Three years through November* –8.45% 1.00 –8.67 Three-year annualized standard deviation 12.98 7.92 15.26 Benchmark HFRI RV ﬁxed-income convertible arbitrage index HFRI fund-weighted composite index Standard & Poor’s 500 index * Annualized. Source: Hedge Fund Research. quest for alpha at the San Diego County Employees Retirement Association is being redeﬁned in hopes of reversing recent enormous portfolio losses. The fund’s “alpha engine,” ﬁrst assembled in 1998, is set to shrink this year to 14 percent of the portfolio from 19 percent. Chief investment officer David Deutsch says some of the 16 hedge fund investments that make up the portable alpha program will be either liquidated or moved to other parts of the $6.2 billion portfolio. Deutsch, who has been CIO since February 2004, is looking for positive performance wherever he can find it. He has devised a “beta engine” to pick up incremental return that, in less stark times, might have been overlooked. The new scheme will allow rapid shifts of up to 5 percent of the portfolio between asset classes as market conditions dictate. The beta engine will run on futures contracts rather than on bought and sold securities, which will keep the fund within its investment policy guidelines. This method is more liquid than trading in actual securities. Although labeled When Beta Looks Good A as a beta engine, Deutsch says it should beat the market: “The gains that we get from this allocation device are alpha — excess return on some skill.” Every little bit helps. From its August inception through the end of December, the beta scheme produced 30 basis points of return, or $27 million, for the pension portfolio. The fund’s main engine — a portable alpha program created to juice returns by “porting” the alpha of hedge fund managers onto the returns of the Standard & Poor’s 500 index — was called into question after the market crash proved disastrous for the strategy, requiring San Diego to make huge payouts to swap counterparties. At year-end the pension fund had lost $2.2 billion of its June 30 value of $8.4 billion. This isn’t the first hurt the Mission Valley, California–based fund has endured. In September 2006 it said good-bye to most of its $175 million investment in Amaranth Advisors when the once–$9 billion ﬁrm lost some two thirds of its assets to a bullish bet on natural gas. Deutsch responded by redoubling his commitment to the alpha engine. The county added two new investment staff members to the team of four, one devoted to the hedge fund portfolio and the other to risk management. It also hired two new investment consulting ﬁrms after Rocaton Investment Advisors — which had recommended Amaranth — was ﬁred in late 2006. Hedge fund specialist Albourne Partners in London and Chicago-based generalist Ennis, Knupp & Associates now split advisory duties at SDCERA. A month before the Amaranth meltdown, a San Diego civil grand jury found the county pension fund to be underdiversified. As a remedy newly hired Albourne recommended doubling the hedge fund allocation from — F.D. eight to 16 managers. David Deutsch is rethinking the “alpha engine” that didn’t work so well for San Diego County retirees. FEBRUARY 2009 • INSTITUTIONAL INVESTOR’S ALPHA • 11 TIM TADDER

Table of Contents Feed for the Digital Edition of Institutional Investor's Alpha Magazine - February 2009

Institutional Investor's Alpha Magazine - February 2009 Contents Letter From the Editor Longs & Shorts Digging Out A Call to Mentor Dicey Detroit The Constant Skeptic Cover Story: The Undaunted What Were They Thinking? Dark Days in Greenwich True Stories from the Commodities Files Return of the Native The Quest for Cover Moving On from Madoff

Institutional Investor's Alpha Magazine - February 2009

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