When the largest American public pension fund officially changed its investment strategy, was it a genuine conversion of faith? Last week, the California Public Employees Retirement System (Calpers) announced it would eliminate its $4 billion investment in hedge funds, which may sound substantial, but only constitutes 1.4 per cent of its entire portfolio.
The $300 billion fund had awoken to the gulf between its hedge fund returns of 7.1 per cent last year, versus 18 per cent earned by the rest of the portfolio. In context, the average hedge fund return for public pensions has amounted to 3.6 per cent over the past three years, while American stocks earned over 10 per cent. Adding insult, Calper’s hedge fund fees cost $135 million, but the final decision probably comes down to scale. Calpers is so huge it already can only earn close to the market return, so why pay extra for an incremental benefit at best?
Calpers may finally be getting the arithmetic right, but it still hasn’t got religion. It continues to invest over 10 per cent of its funds in private equity. True, that class has returned 13.8 per cent over the past decade, but remains highly illiquid and costly to manage.
The real driver is a dangerous gambit. Pension funds are trying to close the gap between likely returns and future obligations to retirees, by relying on the mystique of complex alternative investments. The IMF has labeled it “gambling on resurrection,” with other people’s money of course – in this case police and firefighters’ retirements. Calpers CIO Joseph Dear even candidly announced in 2011 that Calpers was planning to “maintain or increase” its use of hedge funds to boost its 7.75 per cent target for returns. (It then had only 70 per cent of the required money to cover benefit obligations.)
Now that trendsetting Calpers has retreated, a few other pension funds might follow its well- telegraphed move. Most won’t, however; they are nowhere near comparable in size, and have clearly bought into specious hedge fund industry arguments like diversification and non-correlation. It’s already obvious that hedge funds have not been delivering sufficient returns to justify their lofty fees. The Calpers decision does not teach anything new.
Vanessa Drucker is American editor of Fund Strategy magazine