(Bloomberg) -- Pensions and endowments are borrowing from the playbook of giant multimanager hedge funds — and giving it a go themselves. 

University of Texas Investment Management Co. and the State of Wisconsin Investment Board — with a combined $230 billion of assets — are among institutions investing in hedge funds in a way that mimics how multimanagers use individual pods of traders to wager on a variety of strategies. 

Each hedge fund essentially becomes a kind of pod. By using customized sleeves, known as separately managed accounts — or SMAs — institutional investors can tailor their trading exposures, save on execution costs and impose their own risk limits.  

“Sophisticated allocators want to invest more like multimanager hedge funds,” said Michael Jordan, chief executive officer of Walleye Capital’s Dockside Platforms, a fledgling business that helps clients structure hedge fund managed account investments. “They’re saying, ‘Let me take some learnings, practices and structures of these firms to inform how I invest.”

Other firms offer a similar approach, such as Lighthouse Partners and Innocap. The latter’s clients include the Ontario Teachers’ Pension Plan, Caisse de Depot et Placement du Quebec and Los Angeles County Employees Retirement Association.  

In the past year, Innocap has booked $10 billion of client inflows for the strategy — the biggest yearly jump since its founding in 1996, according to a person familiar with the matter. 

Rather than pooling their cash alongside other investors, the institutional clients request that a hedge fund trade theirs separately, allowing them to control leverage and own the underlying assets. That also gives them insight into the exact trades the hedge fund makes — unusual in a world where money-making methods are kept secret. With that knowledge, they can then replicate winning bets elsewhere in their portfolios.  

Comparing Trades

Firms like Dockside and Innocap help allocators invest in hedge funds through managed accounts and negotiate terms. The allocator picks the funds they want as their so-called pods and can compare trades made by the various vehicles. 

Innocap has more than 30 allocators investing in hundreds of hedge funds, while Dockside has six clients so far.  

Utimco, with $74 billion of assets, is one of those six. It has deployed capital to a few managers and intends to increase that to as many as a dozen by the end of next year. In that time, the endowment plans to invest as much as $750 million and use leverage to amp that up to $3 billion of gross market value, it said during a March 20 board meeting.  

Wisconsin’s $156 billion pension fund is invested in 10 managers through Dockside, mostly stock-pickers, and may grow that to as many as 20 by year-end. 

The concept isn’t entirely new. 

The Canada Pension Plan Investment Board and Duke University’s endowment have been running internal hedge fund SMA programs for years. Building out the infrastructure to do so is costly and time-consuming. 

Some firms, such as BoothBay Fund Management, New Holland Capital and Crestline Investors, offer clients exposure to hedge funds through SMAs. They determine which funds to invest in on the allocators’ behalf, risk limits and how to adjust exposures. In these instances, pensions and endowments have less control than with Innocap and Dockside. 

Even multistrats such as Izzy Englander’s Millennium Management and Walleye have been increasingly investing in other hedge funds through SMAs, especially as their assets have grown.

“There has been a massive democratization of the availability of the groups that help investors make their own multistrat,” said New Holland CEO Scott Radke. “It used to be that you access the multistrategy approach by investing in funds like Millennium and Citadel. But now the largest allocators can play the game themselves.”

Institutions aren’t necessarily seeking to replace or compete with their investments in the multistrat giants, which have hundreds of trading teams and are far more complex. 

Traditionally, smaller hedge funds were open to creating the more onerous SMAs in order to boost assets. But Innocap has noticed that some of the industry’s larger hedge funds, those running billions of dollars, have been more receptive in recent years. In a challenging fundraising environment, access to any capital is prized, along with being able to share that a prominent institutional investor is a client.  

SMAs gained favor after the 2008 financial crisis and the Bernard Madoff Ponzi scheme, as investors sought more transparency and the ability to own the assets. Now they’re in even more demand.

The amount of cash hedge funds manage in such pools has jumped by almost 50% over four years, reaching $226 billion at the end of 2022, according to a Goldman Sachs Group Inc. report last June. It’s most popular among the biggest institutional investors — those with more than $10 billion of assets — such as pensions, endowments and sovereign wealth funds. 

Of those considering SMAs, 60% plan to use a third-party platform, while 13% intend to build their own operations in-house, according to a fourth-quarter Morgan Stanley investor survey. The remainder plan to do both. 

Rising interest rates prompted the Wisconsin pension to act. 

It typically borrows capital to make hedge fund investments, but that became too expensive. Using Dockside’s prime brokerage relationships means it can turn a smaller stake into more exposure. Plus, efficiencies such as offsetting buy and sell orders of the same asset across various funds could also trim the expense of executing trades. 

“We can use less capital, reducing our costs significantly, while also targeting our volatility and establishing our own drawdown limits,” said Anne-Marie Fink, the pension’s chief investment officer for private markets and funds alpha. “This approach draws inspiration from the structure of multistrategy funds and their pods.” 

Fink said the quality of hedge fund managers willing to offer SMAs has improved, their willingness to be flexible has grown and the technology and infrastructure supporting SMAs has significantly advanced. 

“As allocators,” she said, “we have developed the internal expertise necessary to manage a multimanager SMA.” 

(Updates with Millennium founder in 15th paragraph. An earlier version of this story corrected the name of Canada Pension Plan Investment Board in 13th paragraph)

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