Institutional Investor's Alpha Magazine - March 2008 - (Page 38) David Shukis with an average allocation of 18 percent. Almost a quarter of the assets that the firm advises on — $20.2 billion of a total $85 billion — are invested in hedge funds. For a 50-basis-point fee, Cambridge hedge fund clients receive the services of 11 researchers who work full time on gauging manager performance. Cambridge also has 28 formal hedge fund consultants, essentially portfolio managers. The consultants select funds for clients and structure and monitor each portfolio. Among those employing Cambridge is the $3.3 billion Annie E. Casey Foundation, whose core mission is to shape public policy affecting children and families. Cambridge manages and monitors one third of the Baltimore-based institution’s $600 million hedge fund allocation, and has done it well, according to Burton Sonenstein, the foundation’s CIO. “Our Cambridge Associates portfolio of $200 million returned 15 percent net of fees last year, and more than 12 percent [annually] in the two years ended December 2007,” Sonenstein reports. The returns on the assets managed by Cambridge were the highest of the four firms that advise on the foundation’s hedge fund portfolio (the others are Rock Creek Group in Washington and Aetos Capital and Morgan Stanley in New York). Sonenstein points to Cambridge’s avoidance of hedge fund catastrophes. “We’ve had our share of hedge fund blowups — like Amaranth and Sowood — but there haven’t been any events in Cambridge Associates’ portfolio,” says Sonenstein, who plans to add $50 million this year to each of the Cambridge and Rock Creek pots. Shukis and his team track and maintain a database on 1,600 funds and invest in about 400 of them. They meet an additional 400 or so new hedge fund managers a year, follow up with about 70 of those and recommend perhaps four to ten to clients. Shukis says Cambridge is aggressively looking for proven managers. “Occasionally, we will recommend a start-up firm if the team has direct experience and good credentials and an identifiable record of having done what they’re proposing to do,” says Shukis. He declined to provide performance returns for Cambridge’s group of 400 managers, but they are presumably better than what Shukis says is the median return for the large group of 1,600 — 11.5 percent in 2007 and an annualized 11.8 percent over five years. Alpha Senior Writer Frances Denmark talked with Shukis about his views on the recent market volatility, how to manage beta and what the future holds for the hedge fund industry. Alpha: What concerns you most now about your clients’ hedge fund investments? Shukis: A more volatile market and some significant down- by shorting individual securities. We also want to see that they are demonstrating skill in what they’re choosing to short because we may well be in a market environment where that’s an important contributor to returns. How are you dealing with the beta in hedge fund portfolios? We’re looking very hard to be sure that the historical return that managers have derived is largely driven by alpha and not just by market exposure. In a long-short portfolio, for example, you can see how much net exposure there is to the market. But the betas of the long and short portfolios can be quite different. The longs may be more sensitive to the market than the shorts if there are more volatile companies in the long portfolio and more stable companies in the short. You have to know something about what the holdings are and the nature of each part of the portfolio to get a handle on its risk level. What has been the effect of the market turmoil on your clients? The frequency of our conversations with clients has increased a bit over the past six to nine months. Generally, last year clients were very pleased with how their portfolios came through the difficulties. In our client portfolios there wasn’t much long exposure to the credit problems, and many investors made a lot of money being short subprime and other credit sectors. Long-short managers last year generally did extremely well. It was a very favorable environment for fundamental long-short strategies when you had enormous dispersion among sectors and geographies and style and individual securities within sectors. What about the most recent downturn? The market faced difficult months in January and February. I think that if you look at hedge fund indexes versus long equity indexes, hedge funds experienced only a small percentage of the decline in markets, but I think there is still a fair amount of anxiety. Certainly, a lot of hedge fund managers had losses in January, and that always gets clients’ attention, but many bounced back in February with positive returns despite the continued slide in equity indexes. How are you handling the continuing credit crisis? ward movement. We need to be sure that both we and our clients understand the amount of beta they have in their portfolios. We’re trying to be sure that we are recommending managers who can make money on their short portfolios, as most of our long-short managers have been doing 38 • INSTITUTIONAL INVESTOR’S ALPHA • MARCH 2008 We want to be sure that our clients are positioned to take advantage of the fallout from the credit crisis and a potential recession in terms of distressed investments, both through their multistrategy managers and also through dedicated funds investing in distressed securities. There seem to be a lot of opportunities in the current environment, both from the credit crisis and also from the likely increase in defaults when the economic slowdown ultimately affects companies’ ability to stay afloat. We’re doing a lot of work on that. What does that work entail? We’re looking for managers. We’re looking at client port-
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