In a move that will be noticed the world over, especially among money managers, Calpers, America’s biggest public pension fund, has revealed plans to stop investing in hedge funds.
It’s a severe blow to hedge funds and their promoters from a highly respected global funds manager and will add to the growing scepticism over the high returns and fees in the once glamour sector of finance.
But in Calpers’ opinion that has happened and its 2013 experience tells the story – its hedge fund investments returned 7.1% and the S&P 500 was up 32%, and the fund paid its hedge fund managers around $US135 million for that underperformance.
In Australia, hedge fund investments are held by funds large and small. Known as alternative investments, fund managers hold them for performance above that from investing in equities directly.
For instance the country’s Future Fund had just over $14 billion or 14.6% of its assets invested in alternatives at the end of 2013, against $13.9 billion, or $16.3% at the end of 2012.
By that comparison it seems the future fund didn’t add to its investments in this area in 2013, and that the rest of the portfolio grew much faster than its alternatives. The overall fund grew by around 16% in 2013.
Calpers is the California Public Employees’ Retirement System. It has $US300 billion in assets and 1.6 million members in California.
And while it joins a growing, but still small list of US public pensions funds which have abandoned hedge funds in the past year or so, it is by far the most important manager to leave the sector.
Despite this growing amount of scepticism, hedge funds have grown to be $US2.8 trillion industry today, according to US estimates.
Calpers’s growing disenchantment with hedge funds had already seen it cut the amount of money allocated to hedge funds by half, to about $US2.5 billion earlier this year.
But it went much further on Monday evening, branding hedge funds too complex and costly and announcing it would exit 24 hedge funds and six hedge fund-of-funds valued at $US4 billon.
The move to reduce its hedge fund holdings became public a week or so ago. At that stage it was thought that was as far as Calpers would go.
Now that has very quickly become complete abandonment of this once high flying class of asset managers.
The decision came after months of deliberation by the pension fund’s investment committee.
Calpers said it will spend the next year strategically exiting its current hedge fund investments “in a manner that best serves the interests of the portfolio."
Calpers move will echo across the US investment community where large investment funds (especially those managing public sector pensions) regard it as a role model because of its size and the sophistication of its investments.
The Financial Times says other US pension funds to have reduced or exited their hedge fund investments include the Los Angeles Fire and Police Pensions system, the Louisiana Firefighters’ Retirement System, and the San Diego County Employees Retirement Association.
The FT said that the Calpers decision doesn’t mean its move is part of 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,” the FT said.
The US is also the home of hedge funds where money managers large and small now offer exposure to them, either directly or indirectly (through the so-called ‘fund of funds’ model).
“We are always examining the portfolio to ensure that we are efficiently and cost-effectively achieving our risk-adjusted return goals,” said Ted Eliopoulos, Calpers interim chief investment officer.
“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 ARS program [the fund’s Absolute Return Strategies programme] is no longer warranted.”
Calpers said its decision was not driven by the performance of its hedge funds (which wasn’t brilliant).
What makes the decision noteworthy (besides the fact that Calpers has made it) is the fact that the fund manager was an early entrant into hedge funds back in 2002.
But the industry’s typical fees of 2% of assets and 20% of returns have begun to pall for more and more fund managers as returns have slowed and asset growth become tougher to find..
This decision follows Calpers adoption of a new asset allocation mix in February, aimed at cutting risk to the portfolio, while maintaining a goal of 7.5% returns a year.
That in turn followed the adoption a year ago of a set of investment beliefs, which Calpers pointedly noted included: “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”.
In other words Calpers wants more reward from hedge funds for the higher risks associated with their investment style, at a lower cost. Hedge funds failed that rule of thumb.
But in the decision Calpers is also responding to the growing lack of performance (which goes to the heart of the new Calpers investment mix and policy)
Hedge funds have underperformed the Standard & Poor’s 500-stock index for the last five years. Last year for instance the index soared by 32%, while the average hedge returned a mere 9.1%, according to US data firm, HFR.
Calpers said it paid $US135 million in hedge fund fees over the financial year that ended on June 30.
It’s hedge fund investments returned just 7.1%, adding 0.4 percent to the firm’s total returns.
For its hedge fund investments to have a material impact, Calpers would have to increase its hedge fund investments to at least 10% of its total portfolio, which was not a feasible option, according to Joe DeAnda, a spokesman for Calpers, quoted by the New York Times.
