Pension funds to continue hedge fund allocations despite CALPERS withdrawal

23 Sep, 2014

Pension funds will continue to increase their exposures to hedge funds although fees are likely to face more scrutiny going forward following the high-profile exit from hedge fund investing by California Public Employees’ Retirement System (CALPERS).

One prime broker executive, who did not wish to be named, said institutional money, particularly from pension funds – many of whom are struggling to meet ever growing liabilities – would continue to flow into hedge funds. However, he said pension funds were more concerned with fees than most investors, and downward pressure would likely be exerted on the traditional 2% management fee and 20% performance fee model.

A study conducted by Barclays Prime Services at the beginning of 2014 predicted hedge funds would see inflows of $80 billion over the course of the year. Of these flows, 60% would be derived from institutional investors, with public and private pension funds comprising 45% of that.

“Hedge funds are astute money managers, and pensions would do well to up their exposures to the asset class. But the industry must be aligned with the interests of long-term allocators. Investors are willing to pay a fee if the performance is solid, and consistent,” commented Thom Young, managing director at OptCapital in North Carolina.

While there has been growing fee scrutiny by investors, the impact has been negligible. The capital introductions arm at Goldman Sachs found in its annual investor survey that the average management fee to be 1.6 per-cent and the average performance fee to be 18.1 per-cent in 2013, a marginal drop from 2012. A survey of clients by New York-based law firm Seward & Kissel reached a similar conclusion, finding management fees stuck at around 1.6% while performance fees continue to be pegged at 20%.

The decision by CALPERS, the biggest US public pension fund, to withdraw from hedge funds did cause debate, having been an early adopter of the asset class. Nonetheless, it announced last week that it would withdraw $4 billion from 24 hedge funds and six funds of hedge funds, and in the process criticised the industry for being too complex and costly. A handful of pension plans are also reducing or terminating their hedge fund exposures. These include the Los Angeles Fire and Police Pensions System, San Diego County Employees’ Retirement Association and Louisiana Firefighters Retirement System.

It was also reported that the £4.5 billion London Pensions Fund Authority (LPFA) sympathised with CALPERS’ decision, adding that hedge fund fees were unjustifiable. The LPFA notably withdrew from Brevan Howard earlier in the year after the $37 billion manager refused to meet the pension plan’s transparency requirements.

“The decision by CALPERS was not unexpected and it had been reducing its hedge fund exposure for some time now. However, it is a high-profile name, so of course everyone is focused on it. But the decision by CALPERS does not change the underlying trend that pension fund allocations to hedge funds are growing. The allocation CALPERS had to hedge funds was small – around 2% - so any impact hedge fund performance had on CALPERS’ returns was going to be minimal. Such a small investment is almost not worth having given the amount of work hedge fund investing entails. If a plan of that size is 10% to 15% invested in hedge funds, which some endowments and pensions are, the material effects of hedge fund performance will be more noticeable,” commented the prime broker.

The growing hostility to the asset class comes following another year of below-par investment returns. The average hedge fund has posted gains of 3.48%, according to data from the Chicago-based Hedge Fund Research.  “Investors must not be short-termist with hedge fund investing,” commented the prime broker.



pension fundsBarclaysCalPERSOptCapitalHedge Fund ResearchGoldman SachsBrevan Howard