Major Texas Pension Makes a Big Push Into Hedge Funds

By CRAIG KARMIN

July 14, 2007; Page B1

Pension funds -- traditionally among the stodgiest investors around -- are starting to dabble in hedge funds, real estate and other "alternative" investments once considered too dicey. Now, a major fund in Texas is about to place a much bigger bet.

The Teacher Retirement System of Texas is planning to shift about one-third of its $112 billion in assets to alternative investments. It's one of the largest-ever pension-fund wagers on investments like these.

Manning the controls is T. Britton Harris IV, the new chief investment officer at the Texas Teachers fund and -- briefly -- the former chief executive officer at Bridgewater Associates, the Connecticut-based hedge-fund group with about $165 billion under management.

Mr. Harris's strategy aims to boost returns by a modest 1% annually, though that would earn his fund an additional $1 billion a year. "We'll be able to produce these higher returns with the same level of risk," Mr. Harris, 49 years old, says.

Alternative assets like these, he points out, usually don't move in lockstep with stocks and bonds, helping to diversify a portfolio. "Investment in alternative assets has not hurt returns at other pension funds," he says. "They have helped returns."

His critics, however, are wary. The recent meltdown by two Bear Stearns hedge funds that invested in subprime mortgages was the most recent reminder of the potential risks involved. And less than a year ago, the hedge fund Amaranth Advisors squandered an unknown amount of pension-fund money while losing $6 billion on natural-gas bets that went wrong.

Pension funds nationwide are buzzing about this Texas-sized overhaul and will be watching to see if the gambit by the nation's seventh-largest public fund pays off. The result could shake up the $1 trillion pension-fund industry by helping to accelerate the trend toward hedge funds and other alternative assets -- or, on the other hand, by stigmatizing these investments if Mr. Harris's fund does poorly.

"We're going to see more of these shifts to hedge funds and other alternatives," says Monica Butler, head of U.S. consulting for Russell Investment Group, which advises pension funds. "But most funds don't want to be among the first to do it."

Pension funds have invested limited amounts in real estate and private equity for at least two decades. More recently, as liabilities have ballooned and begun to exceed assets at many pension funds, the more aggressive have looked to hedge funds in hopes of closing that gap.

So while the Austin-based pension fund isn't the first to dabble in these investments, its shift is radical. Currently, the fund ranks among the more conservative in these investments: It has only about 5% of assets in hedge funds, private equity and real estate combined, less than half the level of the average pension fund.

During the next couple of months, Mr. Harris says, he will begin a two- to three-year process that will raise that amount to around 30%.

Some skeptics have thrown roadblocks in his way. The Texas state legislature recently passed a law capping the amount of money that Texas Teachers can place with hedge funds at 5% of total assets, just half of what Mr. Harris had targeted. That curtailed his plans a bit, forcing him to roll back his investment plans in hedge funds.

Texas Pension Review Board chairman Frederick "Shad" Rowe applauds these limits, arguing Texas Teachers is moving too much money too quickly into hedge funds. "It might be more prudent for them to go a little slower," he says.

Pension funds have been burned by hedge-fund blowups before. The San Diego County Employees Retirement Association is suing Amaranth for $150 million, alleging that the collapsed hedge fund failed, among other things, to properly guard against risk.

The International Trade Union Confederation, the world's biggest union with 168 million members in more than 150 countries, recently claimed that private-equity funds -- which often invest in companies, then lay off workers as part of a restructuring process -- shouldn't be rewarded with pension-fund money. Others say the nature of private equity (where investments may take five years or more until a restructured company is sold and gains are realized) is ill-suited for pension funds with more regular liabilities.

None of these reactions seem to surprise Mr. Harris, who has been involved in the pension world for more than two decades. "I haven't found anyone in the business who doesn't like [alternative assets] as a long-term strategy," he says. "All the concerns are with implementation."

Mr. Harris was born in Bryan, Texas, the son of a Mobil Oil executive who moved the family overseas to Ankara, Turkey, when Mr. Harris was a child. He returned to the Lone Star state to get a degree in finance from Texas A&M, where he now teaches a course, "Titans of Investing," about legendary money managers like Berkshire Hathaway's Warren Buffet and John Neff of Vanguard.

His own financial career began in the mid-1980s as an analyst with the Texas Utilities pension fund. He was part of a team that helped triple the fund's assets to $1 billion. In 1991, he began running the stock-investing division for GTE, a phone company that would later merge with Nynex and eventually become Verizon.

As head of the Verizon $70 billion pension fund, he acquired a taste for alternative investments, putting 17% of the fund's assets into them. After that success, Bridgewater, which managed money for Verizon, hired away Mr. Harris to be CEO.

But this merger of two heavyweights wasn't destined to last, despite Mr. Harris's enthusiasm for alternative investments. Bridgewater's nonhierarchical management style, where there's considerable arguing to come up with the right answer, didn't appeal to Mr. Harris. "After six months of reflection, Britt decided it wasn't for him," says Bridgewater chief Ray Dalio, adding that the parting was amicable.

Mr. Harris agrees: "I do not think that they needed to change what had been a winning formula for years."

In his current job, Mr. Harris believes that many of his pension-fund peers are eager to follow his pension fund's footsteps. But if he isn't able to boost the fund's returns? "Then others won't follow us," he says, "And I'll go somewhere else."