Proposed Investment in Chatham Asset High Yield Separate Account

Memorandum to: State Investment Council
From: Christopher McDonough, Acting Director
Subject: Proposed Investment in Chatham Asset High Yield Separate Account

The New Jersey Division of Investment (“Division”) is proposing an investment of $300 million in a separate account vehicle with Chatham Asset Management (the “Fund”) that will be investing in primarily the same assets on a pro rata basis as the Chatham Asset High Yield Master Fund, Ltd. This memorandum is presented to the State Investment Council (the “Council”) pursuant to N.J.A.C. 17:16-69.9.

The Division is recommending this investment based on the following factors:

  • Successful Track Record: Chatham’s High Yield Master Fund has returned an annualized 8.93% since inception in September 2003 through August of 2013, which is 247 basis points more than the return of the HFRI Relative Value Index in the same time period on an annualized basis. Chatham has also displayed a top-quartile Sharpe ratio on a 1-year and 3-year measurement, as well as since inception. In addition, Chatham has outperformed the S&P 500, the Barclays Agg and the JPM HY index by 181, 415 and 20 basis points respectively since inception on an annualized basis. It should also be noted that Chatham’s performance in 2008 was only -2.57% while the HFRI Relative Value Index was -18.04%.
  • Process-driven Investment Strategy: Chatham’s objective is to combine an active trading approach with a bottoms-up, fundamental-based investment process driven by its credit research operation. The firm attempts to identify fundamental and technical inefficiencies in the pricing of leverage credits across the capital structure, while maintaining a keen focus on underlying liquidity. Active trading is central to the strategy and has led to portfolio turnover averaging 1x per month, and allows for the firm to constantly test liquidity and market sentiment. However, specific name turnover has averaged only 5 – 10% per month. This displays the firm’s intensive research process and conviction around certain companies and credits while maintaining flexibility to move throughout its capital structure.
  • Attractive Terms: The Division believes it has negotiated market-leading terms. They are as follows:
    • Management Fee: 0.75%
    • Preferred Return: 3.00%
    • Carry: 20%, calculated over a two year period, further aligning interests
    • Optional Redemption: Optional redemption if NAV declines 20% from prior year peak
      NAV OR if 50% or more of LP assets submits notice of redemption
  • Disciplined and Respected Investment Manager: Chatham has a track record of returning capital to investors when they do not have an attractive opportunity set, as they did in 2005 – 2006 when they returned $800 million to investors.

A report of the Investment Policy Committee (“IPC”) summarizing the details of the proposed investment is attached.

Division Staff and its hedge fund consultant, Cliffwater LLC, undertook extensive due diligence on the proposed investment in accordance with the Division’s Alternative Investment Due Diligence Procedures.

As part of its due diligence process, staff determined that the fund has not engaged a third-party solicitor (a “placement agent”) in connection with New Jersey’s potential investment.

We will work with representatives of the Division of Law and outside counsel to review and negotiate specific terms of the legal documents to govern the investment. In addition, the proposed investment must comply with the Council’s regulation governing political contributions (N.J.A.C. 17:16-4).

Please note that the investment is authorized pursuant to Articles 69 and 100 of the Council’s regulations. The Chatham Asset High Yield separate account will be considered a credit- oriented hedge fund investment, as defined under N.J.A.C. 17:16-100.1.

A formal written due diligence report for the proposed investment was sent to each member of the IPC and a meeting of the Committee was held on November 8, 2013. In addition to the formal written due diligence report, all other information obtained by the Division on the investment was made available to the IPC.

We look forward to discussing the proposed investment at the Council’s November 21, 2013 meeting.

Source: State of New Jersey State Investment Council