The California Public Employees’ Retirement System, the nation’s largest pension fund, will eliminate all of its hedge fund investments over the next year on concerns that investments are too complicated and expensive.
The pension fund, which oversees $300 billion, said on Monday that it would liquidate its positions in 24 hedge funds and six hedge fund-of-funds — investments that total $4 billion and more than 1 percent of its total investments under management.
The decision, after months of deliberation by the pension fund’s investment committee, comes as public pensions across the United States are beginning to assess their exposure to hedge funds. It is likely to reverberate across the investment community in the United States, where large investment funds look to Calpers as a model because of its size and the sophistication of its investments.
“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 hedge fund program “doesn’t merit a continued role,” Ted Eliopoulos, the interim chief investment officer of Calpers, said in a statement.
Calpers oversees investments and retirement benefits for 1.6 million teachers, police officers, firefighters and other public employees. It said it had not decided where it would invest the money it divests.
“I’m a little shocked at what Calpers is doing,” Charles J. Gradante, managing principal of the hedge fund advisory firm Hennessee Group. “Hedge funds are the place to be now because people are expecting a major correction. You’re looking at a very bumpy stock market over the next five years and that is where hedge funds will prove their mettle.”
A growing number of pension funds and institutional investors have expressed concern that the fees that hedge funds charge are too high. While there is a range, hedge funds typically follow a “2 and 20” model where investors pay management fees of 2 percent of the total assets under management and 20 percent of the profit.
These concerns have become more pronounced as performance across the hedge fund industry has disappointed investors. Hedge funds have underperformed the Standard & Poor’s 500-stock index for the last five years, a metric that pension funds frequently cite as a comparison. In 2013, for example, the average hedge fund returned just 9.1 percent, according to the data firm HFR. That compares with a 32.4 percent increase in the S.&P. 500.
Calpers said it paid $135 million in hedge fund fees over the financial year that ended on June 30. The hedge fund investments returned just 7.1 percent, 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 percent of its total portfolio, which was not a feasible option, according to Joe DeAnda, a spokesman for Calpers.
Even as some pension funds are reconsidering their investments in hedge funds, the industry has continued to grow to a record $2.8 trillion today, according to HFR.
After the pension funds had their asset values decimated by losses from the financial crisis, many of them flocked to hedge funds, and their promise of high returns, even in years when the broader stock and bond markets were down. Some pension funds vastly increased their hedge fund holdings, with many going from virtually no holdings to allocations of up to 15 percent. The Teachers Retirement System of Texas went so far as to take a stake in the giant hedge fund Bridgewater Associates.
But even as some other pension funds piled into hedge funds, Calpers has long harbored doubts about the value of these investment strategies. Those doubts surfaced last year when Calpers investment staff was surveyed about their broad views on investments. Many members expressed “low conviction” that hedge funds should play an important part of Calpers overall strategy.
On average, hedge funds still make up a relatively small portion of large public pension plan’s investments — about 1.3 percent as of June 30, according to the Wilshire Trust Universe Comparison Service. That share is up from about 1 percent in 2007, but stocks and bonds still make up most of pension investments.
Lately, other pension fund managers in states including Rhode Island and Pennsylvania have expressed similar doubts about whether the hedge funds’ recently spotty track record justifies the high fees.
The Los Angeles Fire and Police Pensions led the charge in May of last year when it announced it would exit its hedge fund positions — which made up a total of 4 percent of their assets under management and 17 percent of the fees the firm paid.
The moves are part of a broader reckoning for public employee pension plans. Facing historically low interest rates, a growing number of city and state pension officials have started lowering their annual investment targets, despite the promises of hedge funds, private equity and other high-priced investment managers to continue delivering high returns.
Some investors dismissed the move by Calpers. “It’s an admission by Calpers that they don’t have the right staff or the right managers,” Anthony Scaramucci, founder and co-managing partner of SkyBridge Capital, a global asset management firm, said.
