UPDATE 1-Massachusetts state fund drops 4 hedge fund firms

Tue Oct 13, 2009 6:01pm EDT

* State fund exits portable alpha strategy

* Expects $1.6 bln to be returned by end of 2010

* Will redistribute bulk of funds among other managers (Adds details on plan, quotes)

By Svea Herbst-Bayliss

BOSTON, Oct 13 (Reuters) - Massachusetts will remove $1.6 billion from hedge fund managers Blackstone (BX.N), Crestline, EIM Management, and Strategic Investment Group as it shifts its investment strategy after suffering recent heavy losses.

Trustees for the roughly $40 billion fund voted on Tuesday to pull out of four firms that used portable alpha, a once popular technique employed by pension funds to beat markets that underperformed during the financial crisis.

"This is a strategic shift and not a dissatisfaction with the individual managers," said the pension fund's chief investment officer, Stanley Mavromates.

The move comes at a time many big investors -- ranging from endowments to pension funds -- are rethinking their strategies after a brutal year where some trustees said they lost their taste for riskier investments.

Betting on portable alpha backfired badly for Massachusetts, costing the fund 46 percent during the year that ended on June 30. Massachusetts had long ranked among the best performing public pension funds.

The fund's trustees voted in August to scrap use of the strategy, but only decided on Tuesday which managers would be let go.

The state will likely have to wait until 2010 to get its money back. Many hedge fund managers, unlike mutual fund managers, return investments only periodically.

Mavromates said most funds should be back by the middle of 2010 and all will be returned by the end of next year.

Blackstone is expected to return $200 million while EIM will give back $172 million. Crestline will return $670 million and Strategic Investment Group will return $650 million, Mavromates said.

STATE STICKS WITH SOME HEDGE FUNDS

Even though Massachusetts, one of the first state pension funds to bet big on hedge funds, is abandoning portable alpha, it is sticking with loosely regulated portfolios and even plans to increase the amount of money it allocates to them by the middle of next year.

Since making its first bet on hedge funds five years ago, the state fund has seen an annualized return of 4 percent from those funds, far more than the 1 percent return delivered by the Standard & Poors 500 index during the same time.

"We are $1 billion better off because we bet on hedge funds," Mavromates said.

Massachusetts had allocated 5 percent directly with hedge funds and had a 6 percent portable alpha investment, for a total of 11 percent earmarked for absolute return strategies. Now the fund will allocate 8 percent to alternative strategies.

By the middle of 2010, Mavromates said the pension fund will have $3.2 billion in hedge funds, up from the $2 billion it has in right now.

Most of the money coming out of the portable alpha program will be redistributed among Arden Asset Management, K2 Advisors, Pacific Alternative Asset Management Company, Rock Creek Group and Grosvenor Capital.

The hedge fund of funds groups Arden, K2, PAAMCO and Rock Creek were among the firms that helped the state select which hedge funds to invest with.

After the chaos of the past few years, Mavromates is imposing new controls on these managers as well.

"Each manager will be more focused," he said. "They will have tighter guidelines that will play to their strengths." For example Rock Creek with be asked to focus exclusively on non-U.S. investment strategies. (Editing by Steve Orlofsky)

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