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Will Pension Funds Leave Hedge Funds?

There are growing concerns that hedge funds, referred to as the “gold rush of the 21st century,” are troubling investments for pension funds.1 For instance, pension funds have decreased their investments in hedge funds by 25% from 2011 to 2014.

2 In September 2014, Calpers, the California Public Employees’ Retirement System, stunned the investment world by announcing that it would divest the $4 billion it had invested in hedge funds.3 As one of the largest pension funds, it caught everyone’s attention, but the reason Calpers decided to leave the hedge fund world was less surprising.

Hedge funds generally take a 2% assets-under-management fee along with a 20% performance fee. With these expensive fees, Calpers stated that it spent $250 million in hedge fund fees in the last two fiscal years.4 While high costs are paid without complaint if they positively correlate with high returns, Calpers only experienced returns of 7.1% from hedge funds in the last fiscal year, compared with a 24.8% return on global equities.5 Calpers experienced a string of poor returns with its worst fund returning a loss of 37% in the last three fiscal years.6 As the hedge fund world became oversaturated with funds and managers, it has become increasingly hard to select the right investments. Overall, Calpers stated that it wasn’t worth the risk to continue to invest in hedge funds when fees were so high and performance was less than stellar.7

The million dollar question is whether other pension funds will follow suit. Perhaps the two million dollar question is whether pension funds should follow suit. Calpers is the country’s largest pension fund, so its decision is bound to raise eyebrows and cause pension funds to reexamine their investments. Hedge funds have “vastly underperformed the Standard & Poor’s 500 stock index over the last one, three and five years.”8 For instance, the HFRX Global Hedge Fund Index, “which provides an aggregate view of hedge fund performance,” shows that from 2003-2013, the HFRX annually gained 1% while the S&P 500 returned 7.4%.9 The Barclay Hedge Fund Index shows similar comparisons as returns were only 2.89% in 2014, while the S&P gained over 13%.10

Another problem is the lack of transparency that hedge funds provide. Chris Tobe, a former trustee for the Kentucky Retirement Systems, stated that the contract review committee and auditors weren’t allowed to look at the hedge fund contracts, preventing them from determining whether the hedge funds were overcharging them on their fees. (Morgenson, supra note 8.)) Hedge funds are also known for hiding “securities holdings, trading costs and custodians.”11 Perhaps an even worse investment for pension funds is the fund of funds, which is an investment vehicle that holds a portfolio of other hedge funds. Fund of funds typically charge additional fees and simply “duplicate investments in other hedge fund portfolios.”12 Pension funds should also be very cautious when attempting to mimic the successful Yale endowment, which invests in similar investment vehicles. In addition, pension funds’ cash flow requirements differ from endowments, as they have to make regular payments to retirees.13

Some pension funds are moving away from hedge funds for other reasons. One of Dutch’s largest pension funds, PFZW, recently stated that they were divesting their investments in hedge funds because of their “limited concern for society.”14 This suggests that pension funds may be removing hedge funds from their portfolios because of political, rather than financial, reasons.

Some commentators suggest that pension funds should continue to invest in hedge funds. First, the current climate of low interest rates reduces possible returns on passive investments.15 Second, as pension funds start to invest in commercial real estate, they should realize that returns on prime real estate in cities such as Hong Kong and New York have decreased and are still risky investments.16 Even with the high fees, some suggest that “hedge funds have delivered higher returns than most pension funds have been able to.”17

The jury is still out on how pension funds will act. For instance, there’s been public contention for the past six months between the chief investment officer, public speakers, and board members of the San Francisco Employees’ Retirement System on whether the pension fund will invest in hedge funds.18 However, after a long and spirited debate, the pension fund’s board voted “this month to allocate 5% of its $20 billion in assets to hedge funds.”19

  1. James B. Stewart, Hedge Funds Lose Calpers, and More, NY Times (Sep. 26, 2014), 

  2. Christopher Swann, Why Hedge Funds Still Make Sense for Pension Funds, NY Times (Mar. 10, 2015), 

  3. Stewart, supra note 1. 

  4. Id. 

  5. Id. 

  6. Id. 

  7. Id. 

  8. Gretchen Morgenson, Slamming a Door on Hedge Funds, NY Times (Sept. 20, 2014), 

  9. Carl Richards, Picking the ‘Right’ Hedge Fund Involves More than Looking in the Past, NY Times (Sept. 22, 2014), 

  10. James B. Stewart, As Hedge Fund Returns Falter, Money Continues to Flow In, NY Times (Feb. 26, 2015), 

  11. Id. 

  12. Id. 

  13. Id. 

  14. Swann, supra note 2. 

  15. Id. 

  16. Id. 

  17. Id. 

  18. Morgenson, supra note 8. 

  19. Stewart, supra note 10.