In this issue:

Mr Henry moves to Hershey, Hedge Fund smoke, I need a Fund of Funds pro

Eric Henry lands a sweet job in Hershey, PA

Are Hedge Funds returns just a mirage?

Skorina needs a senior Fund of Hedge Funds pro


Our CIO performance-for-pay index re-revisited: Institutional Investor weighs in

Fran Denmark at Institutional Investor gave us a nice write-up last week, looking at our CIO performance-for-pay study in Skorina Letter 35.

You can see it here:

…or, when it goes behind their pay-wall, it’s also on our website here:

She took the time to chat with me and a couple of the CIOs we indexed, and then wrote a balanced piece which considered both the strengths and weaknesses of our maiden effort at quantifying this previously unquantified factor.

If you want to look at the study and form your own opinion, it’s archived on our website, here:


Comings and Goings:

From Motown to Chocolatetown – Eric Henry gets a sweet deal at the Hershey endowment:

Eric Henry, startup chief investment officer for the $55 billion UAW Retiree Medical Benefits Trust in Michigan, has been hired as CEO and CIO of the Hershey Trust Company in Hershey, Pennsylvania, which invests about $8.5 billion of charitable capital.

It’s a good move for Mr. Henry, whose 2010 salary in Michigan was $499,332. The Hershey job paid the previous CIO $948,424, and will presumably pay Mr. Henry as much or more, given that he will also get the CEO hat.

Mr. Henry’s successful and peripatetic career has taken him full circle: from Pennsylvania, to New Hampshire, to Pennsylvania (again), to Texas, to Michigan; and now back to Pennsylvania, still again. In Hershey he will be just a stone’s-throw from Harrisburg where he previously served as executive director at the Pennsylvania SERS pension.

The UAW trust holds the funds for a so-called VEBA (Voluntary Employee Benefit Association), which pays health benefits for retired auto workers. It was spawned by the massive federal bailout of the Detroit automakers in 2008/2009.

Bankrupt GM and Chrysler and not-quite-bankrupt Ford needed to offload their retiree medical liabilities from their own cratered balance sheets. A complex, high-stakes negotiation between companies, unions and the Feds midwifed the VEBA, which opened its doors in Ann Arbor in January, 2010. To fund those liabilities, the trust got company stock, some cash, and other odds and ends.

The new board, following recommendations by Hewitt EnnisKnupp, wanted a portfolio that was both more conservative and more liquid than what they were originally handed. The man they hired to set up an investment office and execute the plan was Eric Henry, a veteran institutional investment hand they hired away from a public pension in Texas.

He’s taken some notable steps to unload some of those legacy assets. Last March, for instance, he found a window in which to sell a bushel of Ford stock warrants that were on their books at $360 million; a one-day auction raised $1.8 billion for the trust. Ford stock was then at $13.50, up from just $2 in 2009. That made the warrants with their $9.20 per share striking price an attractive speculation at $5.

Presumably most were bought by hedge funds and, if they were clever enough to sell at the market peak early this year, they could have almost doubled their investment in 10 months.

Mr. Henry had faced a different kind of portfolio makeover job when he was hired by the Texas MRS pension in 2007. MRS, a defined-contribution plan, had been invested almost entirely in bonds and he was tasked to diversify them into a more conventional multi-asset portfolio. He seems to have made a good start in his two-year stint as executive director and CIO.

When he arrived in Austin in 2007, the $15 billion pension was 98 percent invested in fixed-income; by the end of 2009, he had worked it down to just 66 percent. It was fortunate for all involved that they didn’t diversify any faster or earlier; sitting on a lot of Treasuries, cash, and high-quality bonds was exactly where you wanted to be in 2008. Ironically, that allocation he’d been hired to undo saved their bacon. Mr. Henry could point back to an average 3-year return of 5.9 percent as of 2010, way better than most of their more-diversified peers. Timing is everything.

Mr. Henry will now be investing the endowment of the Hershey charities, which was seeded in 1909 when Milton Hershey donated 486 acres of land and $60 million in Hershey stock to start a boarding school for poor children. Most of the money is housed in the Milton Hershey School Trust, but that fund is steered by the Hershey Trust Company, a subsidiary which houses the investment staff.

Mr. Hershey weaved a tangled web when he set up his charities and gave them control of the chocolate company, but it seems to have worked as intended. Anyone who’s interested can consult the convoluted org chart here:

So, Mr. Henry now faces still another un-diversified portfolio, but no one will be expecting him to change that anytime soon. About three-quarters of the Trust’s assets consist of Hershey Company stock. Despite occasional talk about mergers over the past decade, the board of the Trust has consistently tried to maintain control of the chocolate company. We note that the stock price has doubled over the last ten years since all of those “missed” M&A opportunities passed by; so maybe they weren’t so dumb, after all.

The Trust Company is chaired by Mr. Henry’s new boss, Robert Cavanaugh, who stepped up to that job only three months ago. Mr. Cavanaugh is a finance guy himself, a Hershey School graduate with a Harvard MBA.

Although the Hershey Company has its own board, the Trust ultimately controls the chocolate company (with 80 percent of its voting power and 30 percent of its common shares). But that still leaves about $2 billion in publicly-traded non-Hershey assets to deploy in support of the charities, enough to keep Mr. Henry and his staff busy.

It’s striking how often Mr. Henry has held a combined CEO/CIO job. He had that arrangement at the New Hampshire Retirement System (2000-2004), and at Texas MRS (2007-2008). (Since he left, MRS has split the job between two individuals.)

He was just plain executive director at Penn SERS 2004-2007, but is now a double-hat CEO/CIO again at Hershey. He is clearly a full-service manager with a broader skill-set than your average CIO.

I note that he didn’t start as a portfolio manager, either. He was chief of internal audit (and assistant executive director) at Penn SERS (1994-2000). After his 4-year excursion with the $5 billion New Hampshire pension, he was back in Harrisburg, picked for the top job at Penn SERS. In addition to a CPA, he holds a tech-heavy CISA (Certified Information Systems Auditor) ticket.

Mr. Henry earned an accounting degree from Penn State and an MBA at Bucknell University. Being unmarried seems to have made it a little easier for him to negotiate frequent career-moves. I’m told however, that his two loyal dogs accompany him in all his travels.


Skorina needs a senior fund of hedge funds pro with a double-barreled skill-set

He/she must excel at both:

1. Driving a hedge fund selection process and assembling custom hedge fund portfolios, and…

2. Outstanding client-service management and communication.

The right candidate – probably the current head of research or senior member at a large fund of funds – will be snapped up by my client: a multi-billion AUM money manager in the Mid-Atlantic area. The role is a new position reporting directly to the CEO, with a seat on the investment committee.

Compensation will be highly competitive.

Please call or email me: Charles A. Skorina (415-391-3431)


The Hedge Fund Mirage: Were hedge fund investors misinformed?

Rick (Humphrey Bogart): I came to Casablanca for the waters.

Captain Renault (Claude Rains): The waters? What waters? We’re in the desert!

Rick: I was misinformed.

In his new book – The Hedge Fund MirageSimon Lack contends that most hedge fund investors came looking for the waters, but were sadly misinformed. They swarmed into hedge funds based on the excellent historical returns reported by fund managers and industry indexes, but found themselves in a desert of low returns. Those historical numbers, he argues, are fatally flawed.

Our faithful readers may have already have seen Mr. Lack’s core argument. Way back in Skorina Letter 21 we linked to his 2010 article in AR Magazine: Hedge Fund IRR Has Been Pathetic, along with a link to an academic paper (Dichev and Yu, Higher Risk, Lower Returns: What Hedge Fund Investors Really Earn [2009]), which supports his views. If you want the short version, we can save you $34.95 on the book purchase by steering you to that AR piece here:

Here’s an even shorter short version of Mr. Lack’s thesis:

The hedge fund industry grew very fast, from $130 billion in 1998 to $1.6 trillion in 2010 (with a pre-crunch peak at $1.9 trillion in 2007). But if an investor looks at a time-series of an industry index, or the growth enjoyed by a first-dollar investor over ten or fifteen years in a given fund, he will see a number that is not adjusted for that huge fifteen-fold increase in industry AUM.

For instance, the HFR Global Hedge Fund Index (HFRX), using returns from 1998 to 2010, says the HF industry has had an average annual return of 7.3 percent. Compare that to other major asset categories over the same period (5.9 percent for the S&P 500, 3.0 percent for T-bills, and 7.2 percent for corporate debt), figure in the benefit of the vaunted non-correlation offered by hedged “absolute return” strategies, and it all looks pretty darn good. Who wouldn’t want to get some of that?

This is where the mirage lurks, according to Mr. Lack. Returns in those early years were generally higher; returns in the later years were lower. If you adjust each year’s returns by the steadily-rising industry AUM, you get a completely different story. On this basis, funds have returned a paltry 2.1 percent. The average investor got into bigger funds later in the period, and the average dollar deployed by that average investor earned closer to 2 percent than 7 percent. In other words, the average return to the average investor in his average holding period was, as Mr. Lack puts it, pathetic.

As we note above, T-bills earned 3.0 percent in that period. If HFs “really” returned only 2.1 percent for the typical investor, then you would have been better off buying treasuries without paying 2-and-20. Or, maybe you should have just tried your luck on the crooked roulette wheel in the back room of Rick’s CafĂ©.

Of course, he hastens to add:

…saying that hedge fund investors in aggregate have done poorly isn’t the same as saying everybody’s lost money… However, most of us assumed that the average in this case was pretty good, whereas it turns out to be pretty poor.

In math-speak, what Mr. Lack is proposing is that hedge funds and the indexes report an internal rate of return (IRR), or asset-weighted return. We should do this not just to make hedge funds look bad, but because it makes sense.

Mutual funds don’t report IRR; their literature touts first-dollar-invested returns. But that’s OK, because mutual fund managers have no control over the ebb and flow of investor money. But a hedge fund is more like a private equity or real estate vehicle. They can all (more or less) accept or refuse capital and deploy it on their own schedule. Real estate and PE managers report returns on an IRR basis, says Mr. Lack, and so should hedge funds, notwithstanding current industry practice.

In the good old days not only was total industry AUM much smaller, but the average hedge fund was itself much smaller. Mr. Lack firmly believes that smaller funds perform better, and that this is the root cause for declining returns. This is a controversial point, of course. Some studies support small-is-better; some don’t.

There is much more, of course, as there would have to be when you’ve expanding a 700-word article into a 200-page book. There are war stories about how he didn’t invest with Bernie Madoff or with Long Term Capital Management, and some hyper-technical stuff about hedge fund accounting just to show he knows whereof he writes.

Captain Renault: I’m shocked, shocked to find that gambling is going on in here!

Croupier: Your winnings, sir.

Captain Renault: [sotto voce] Oh, thank you very much.

Mr. Lack delivers a fairly shocking analysis (if you’re easily shocked) of how much of the total profits went to the GPs rather than the LPs. But, it doesn’t seem to us that it’s directly germane to investors. If they were earning handsome returns themselves, they might be indifferent to the even handsomer returns to the fund managers. Since they’re not, the enormous profits going to the managers, once revealed, might trigger pangs of envy.

Given the wide attention this book has received, the HF industry and its superstars might be well-advised to have a rebuttal ready. And, if someone out there has one, we’d be happy to print it, or link to it.

When a debunking book like this appears, we naturally wonder about the author’s motives and bona fides. Is he a crank, or a Marxist professor who hates capitalism? Here: no and no.

He came to the U.S. from Britain in 1982 as an FX and debt trader and, through a circuitous route, wound up on the investment committee in charge of finding hedge fund investments for JPMorgan’s elite private banking customers. Specifically, they were seed investors in small funds, one of the first, and a lot of their returns were from sharing in the fee income of their portfolio. In effect, they were venture capitalists in the young hedge fund industry, and did very well at it.

He retired in 2009, and now runs SL Advisors, which advises separately-managed accounts and claims to offer investors all the features which he looked for when he was seed-investing for JPM.


Mr. Lack admires the star hedge fund managers and isn’t accusing anyone of deliberate deception. Rather, he thinks that most of the investors piling into hedge funds have not been operating at the level of JPM’s private bankers.

Investors are all voluntary clients. Hedge funds are meeting a clear demand from the market. And the vast majority of capital is provided by “qualified” investors, either individuals … deemed “sophisticated” or institutions fully capable of accurate analysis. The fact that it hasn’t turned out well is very largely the fault of the investors themselves.

Mr. Lack and his colleagues were super-picky investors who kissed a lot of frogs in those years.

He proudly says:

…we maintained our investment criteria at a consistent standard throughout. As a result, we ran out of compelling places to invest our capital, and by 2006 we told our clients we wouldn’t be deploying their remaining capital and would be returning what we had.

Well, this is all very well, but what is the actionable moral for the rest of us: say, a pension-fund manager?

If you’re going to invest based on looking back at history, invest in something that looks like the history you’re looking at.

In other words, those early returns are ancient history.

Trustees of pension funds, and others in a fiduciary role, should be far more skeptical…

Skepticism is good, but it isn’t a plan. How exactly does he propose that we (meaning you) should invest in those small funds, assuming you don’t just give up and buy T-bills?

You should do it the way his super-smart unit at JPM did it:

A large investor negotiating with a small hedge fund might obtain a separately managed account… Even if that’s not possible, the investor can demand complete daily position, transparency, delivered directly from the custodian or prime broke….

The investor can probably negotiate more attractive fees, perhaps improved liquidity terms, and maybe even a stake in the business if they’re one of the early investors and want to become a seed investor… if the fund does turn out to be a winner, the ownership of the business can turn out to be more lucrative than the investment in the fund.

Oh, and there’s this:

The only way to successfully invest in hedge funds is to be above average at manager selection.

Well, there’s the problem, right there. You’ve only been average manager-selectors, and you should have been above-average! What were you thinking?

Your board and your consultants are probably more risk-averse than JPM’s private banking clients. They want to see funds with sophisticated risk-systems, operational security, long track-records, substantial capital, etc, etc. But these are exactly not the kind of lean-and-hungry startups that made money for Mr. Lack’s team at JPM.

Also, he regrets to tell you that you just may not be smart enough. He postulates that there is a Hedge Fund IQ and, like regular IQ, it is not fairly distributed. In his polite, English way, he lets you know just where you stand in the pecking order. From top to bottom the HF IQ ranking would be:

1. Hedge fund managers

2. Traders who trade with or against the HFs

3. Hedge funds of funds

4. Consultants who advise institutions

5. Trustees and investment committees of institutions

Hedge fund investors need to acknowledge that they are unequal partners with their chosen managers and pursue negotiating strategies that compensate, or invest elsewhere.

If you buy Mr. Lack’s analysis you may not have a usable plan for hedge-fund investing, but at least you’ll have a better notion of what you’re up against.


April in Manhattan with Skorina (and some other people)

April in Paris is OK, but the trains are on strike (again) and, really, it’s not a patch on April in Manhattan. Next month I’ll be in New York for the 2012 edition of aiCIO Magazine’s Chief Investment Officer Summit.

It’s in mid-town this year, at the Harvard Club on West 44th between Fifth and Sixth on April 12 and 13th. It’s a great neighborhood, and very diverse: There’s the Harvard Club, Yale Club, Penn Club, Cornell Club, etc. A chap or chapette can find a congenial spot anywhere on the block. Regrettably, the Oak Room at the Algonquin closed last month, but there’s still plenty to see and do.

The dashing Kip McDaniel and charming Paula Vasan will be your gracious hosts and they have again rounded up some heavyweight presenters from the institutional investment world. I will be dropping in to rub shoulders with my betters and will be delighted to meet any of our readers who can make it.

All the details are available here:

There will be a big-time consultant (Eric Knutzen of NEPC),

a big-time foundation guy (Mark Baumgartner of the Ford Foundation), major corporate-pension people (Brad Leak of Boeing, Carol McFate from Xerox), public pension honchos (Ash Williams of Florida SBA, Cheryl Alston of the Dallas REF), and even a distinguished visitor from the Great White North (Jagdeep Bachher from Alberta’s AIM). And me.

Something for everybody.


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