Coverage: Calpers bailing on hedge funds

After becoming one of the first pension funds to invest in hedge funds, Calpers is one of the first to bail on all their investments, saying it will pull nearly $4 billion from fund managers.

The New York Times had this story by Alexandra Stevenson and Michael Corkery:

The California Public Employees’ Retirement System, the nation’s largest pension fund, will eliminate all of its hedge fund investments over the next year on concerns that investments are too complicated and expensive.

The pension fund, which oversees $300 billion, said on Monday that it would liquidate its positions in 24 hedge funds and six hedge fund-of-funds — investments that total $4 billion and more than 1 percent of its total investments under management.

The decision, after months of deliberation by the pension fund’s investment committee, comes as public pensions across the United States are beginning to assess their exposure to hedge funds. It is likely to reverberate across the investment community in the United States, where large investment funds look to Calpers as a model because of its size and the sophistication of its investments.

“Hedge funds are certainly a viable strategy for some, but at the end of the day, when judged against their complexity, cost and the lack of ability to scale at Calpers’ size,” the hedge fund program “doesn’t merit a continued role,” Ted Eliopoulos, the interim chief investment officer of Calpers, said in a statement.

Writing for Reuters, Svea Herbst-Bayliss and Barani Krishnan said Calpers wasn’t happy with the return for the risk of the investments:

Discussions about hedge funds’ role in the massive portfolio began after Joseph Dear, Calpers’ former chief investment officer, died of cancer in February, people familiar with the fund said.

Dear, who joined Calpers in 2009, embraced riskier assets including hedge funds and private equity funds, to help recover losses suffered during the financial crisis when its investments lost 23.6 percent during the fiscal year that ended on June 30, 2009.

But in the last years, most hedge funds have not delivered the out-sized returns the industry became famous for, prompting many pension funds and other large institutional investors to question hedge funds’ fees which often include a 2 percent management fee and 20 percent of the gains achieved. Hedge funds returned 4.10 percent this year through August, according to Hedge Fund Research, lagging the Standard & Poor’s 500 9.87 percent gain.

“The hedge funds haven’t contributed much to Calpers’ results during the stock market boom, but the right ones could provide a hedge against a drop in the market,” said Erik Gordon, who watches the industry closely as professor of law and business at the University of Michigan.

Bloomberg’s Michael B. Marois said the move could be just the beginning, since Calpers often sets industry trends:

The largest U.S. pension is getting out of hedge funds even as other large public plans such as New Jersey’s add to the private portfolios. Calpers has been working to reduce risk after the global financial crisis wiped out more than a third of its wealth, forcing it to increase contributions from taxpayers to cover losses. Calpers first invested in hedge funds in 2002 to help meet target returns to cover the growing cost of government retiree benefits.

The pension fund paid $135 million in fees in the fiscal year that ended June 30 for hedge fund investments that earned 7.1 percent, contributing 0.4 percent to its total return, according to Calpers figures.

“We do not believe for Calpers’ scale, that we could grow the hedge-fund program to a scale that would be meaningful,” Eliopoulos said in the television interview.

Because of its size, Calpers is often a trend setter among pension funds on investment strategies, said Keith Brainard, research director of the National Association of State Retirement Administrators.

“I would expect their decision to divest from hedge funds will cause some public pension funds to re-evaluate their hedge fund strategy, although many public pension funds consider hedge funds to be a vital part of their diversified portfolios,” Brainard said yesterday by e-mail.

Tom Braithwaite of The Financial Times said the decision by Calpers was based on a recent shift in strategy and may not have anything to do with a larger trend:

It does not necessarily mean that Calpers’ move is part of the trend. US pension funds in aggregate have been increasing their allocations to hedge funds steadily in recent years, and the trend has continued into 2014.

According to the latest survey by Preqin, 34 per cent of hedge funds reported greater capital inflows from public pension funds in the first half of the year.

Calpers adopted a new asset allocation mix in February, reducing risk to the portfolio, while maintaining a goal of 7.5 per cent returns. That follows the adoption in September 2013 of a set of investment beliefs, which Calpers pointedly noted include: “Calpers will take risk only where we have a strong belief we will be rewarded for it” and “costs matter and need to be effectively managed”.

Henry Jones, chairman of the investment committee, said: “While the ARS analysis was no simple matter for Calpers, the Investment Beliefs provide guidance for a straightforward and principled conclusion that fits our needs.”

Whether it is a shift in strategy or a move to stop paying fees, the blow to public perception isn’t great for the hedge fund industry. Just as they were beginning to be seen as more mainstream, and capturing more retail investment dollars, one of the biggest managers (on behalf of regular people) is pulling back. We may see another round of fund consolidation as smaller ones find it harder to attract money.