Given
recent global uncertainty, it should come as no surprise that the general
public is quite dubious over just about everything. Today there is a new
addition to the ever-growing list of uncertainty. According to experts at the Wall Street Journal and The Financial Post, public pensions have
been backing away from hedge funds because of concerns about high fees and poor
returns. The California Public Employees’ Retirement System (Calpers) is the
largest pension fund in the U.S. Experts are now predicting that we can see a
drop in the fund’s hedge investment by nearly 40% to $3 billion. A spokesman
declined to comment on the size of the reduction but said the fund is taking
more of a “back-to-basics approach” with its holdings.
The
officials overseeing pensions for Los Angeles’s fire and police employees, for
instance, pulled out of hedge funds all together following an investment of
$500 million, which produced a return of less than 2% over a seven-year period.
The hedge-fund investment accounted for just 4% of the pension’s total
portfolio. Despite this, $15 million a year in fees have gone to hedge fund
managers.
What
we generally saw before 2004 was a trend of public pensions avoiding hedge
funds all together. It was only a decade ago that public pensions began to
venture out into hedge funds in an effort to boost long-term returns and
minimize the gap between assets and future obligations to retirees. Many hedge
funds have dropped less than the overall market during the financial crisis. Some
have even anticipated this collapse and posted outsized gains. That performance
accelerated the flow of pension money into hedge funds.
Perhaps
this dislike of hedge funds is due to its comparatively high expenses. Hedge
funds are known to charge higher fees (usually 2% of assets under management
and 20% of profits). In addition, hedge funds typically bet on and against
stocks, bonds or other securities (often using borrowed money). Investors
are clearly opting out of alternative investments, including real estate and
private equity. Pension funds are looking to diversify their holdings. They are
hoping that bigger investment gains will help them avoid extracting larger
contributions from employees or reducing benefits for current or future
retirees.
Hedge
funds as investments are still not seen as a viable option within the majority
of the investor community; albeit half the U.S public pensions still have
some sort of hedge-fund investment. Some of the bigger public pensions are
saying that they are holding firm on commitments or increasing allocations as
they are concerned about how stocks will perform in any future downturn.
“We are seeing a little moving away from hedge funds,” but so far
it’s “just on the margin,” said Verne Sedlacek, the chief executive
of Commonfund, a non-profit that manages money for pension funds, endowments
and other non-profit groups.
Due
to the massive influence Calpers has on the industry; any move it makes will
navigate the direction of other public pensions. The current value of its
assets amounts to roughly $301 billion. A Calpers spokesman said the investment
staff will make a formal recommendation to the board in the fall. But some cuts
already have been made, said a person familiar with the situation. Hedge funds
represented 1.5% of Calpers’ total assets, or $4.5 billion, as of June 30.
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