In the midst of the financial crisis, the 92nd Street Y came up with a sweetheart deal for its endowment: investments in funds run by the likes of John Paulson, Marc Lasry, and other hedge-fund luminaries that were fee-free and guaranteed against losses.
The strategy performed well for several years, said people familiar with how it worked, as the Y benefited from risk-free investing in some of the fund industry's most successful strategies. But, concerned about the impact of a catastrophe in which a money manager couldn't repay losses and eager to construct a more diversified portfolio, the Y recently opted to redeem its hedge-fund investments, these people said, and rebuild its financial strategy from scratch. (A Y spokeswoman did not respond to requests for comment.)
Located on Manhattan's Upper East Side, the Y is a cultural mecca, featuring everything from breastfeeding classes for new moms to talks with the Nobel laureate Elie Wiesel. Its enormous board of directors includes the Seagram liquor heir Matthew Bronfman and the Loews family matriarch Joan Tisch, and its exclusive nursery school became infamous in the early 2000s after revelations that the telecom analyst Jack Grubman had manipulated his stock research as a favor to his boss, Citigroup chief Sanford Weill, after Weill helped Grubman's twins gain admission to the Y.
The Y's investment kitty, a roughly $40 million endowment, according to financial statements reflecting the fiscal year ended June 2011 (the most recent report available), is relatively small. But because of its highflying directors, many of whom have sent children or grandchildren through its nursery school, the Y nonetheless had access to top-shelf hedge funds. Over the years, said people familiar with the matter, the Y invested in hedge funds run by John Paulson, the founder of Paulson & Co., Curtis Schenker, the founder of Scoggin Capital Management, Marc Lasry, the founder of Avenue Capital Group, and Ricky Sandler, the founder of Eminence Capital. The first three managers were Y directors in recent years, as was the wife of Sandler.
The Y's investments in the hedge funds, which began around the year 2008, according to one of the people familiar with the matter, was first reported by The New York Times last November.
Shortly after that article's publication, said the people familiar with the matter, the Y opted to terminate its existing hedge-fund investments, which included a reported $10 million in Paulson & Co., whose best-known funds had fallen a respective 53 percent and 36 percent for the year. (Scoggin Capital finished 2011 slightly down and Eminence Capital slightly up, according to someone familiar with the matter and a hedge-fund report. The Y was no longer invested in Avenue, from which it had redeemed money after 2009, according to other people familiar with the matter.)
Although the Y was remunerated for any losses from Paulson or other hedge-fund investments, concerns had developed about the lack of a more diverse portfolio, said these people, and about the possibility that a manager would not be able to reimburse the Y for losses in the unlikely case of a career-ending loss. Some of the hedge-fund managers with whom the Y had invested were also eager to end the fee-free, risk-free arrangements, the person added, given that most hedge-fund investors pay at least 2 percent of their assets toward the fund's operating expenses and give up 20 percent of the upside returns to the fund's managers. Investors also share the pain if the performance is bad.
In recent months, the Y has turned its investments over to a new board member and hired an outside advisor to recommend a new strategy for its portfolio, said the people familiar with the matter. The advisor has suggested a more traditional approach to investing, according to these people, including the possibility of individual stocks and bonds, but not excluding the possibility of hedge funds.
—By CNBC's Kate Kelly; Follow Her on Twitter @KateKellyCNBC