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Deutsche Bank: CalPERS’ Hedge Fund Exit “Has No Bearing” On Allocations Of Institutional Investors

The CalPERS Building in West Sacramento, California.

Deutsche Bank says that after a series of meetings this month with institutional investors, they’ve concluded that CalPERS’ hedge fund exit “has no bearing on most investors commitment to the industry.”

From ValueWalk:

Deutsche Bank prime brokerage notes that hedge funds have been engaged in “extreme protection buying in equities” and said that the recent exit from hedge funds by CalPERS “has no bearing on most investors commitment to the industry.”

After speaking with the institutional investor community regarding their commitment to maintain their hedge fund allocations, Deutsche Bank’s Capital Introductions group reports this positive message that it says was bolstered by recent meetings with Canadian pensions and global insurance companies throughout the month, while a trip to Munich indicated an increase in hedge fund exposure from institutions.

[…]

Separate hedge fund observers, meanwhile will be watching numeric asset flow patterns in December and the first quarter of 2015 to determine on an objective basis if there has been a statistical move away from hedge funds.

Even if institutional investors on the whole aren’t moving away from hedge funds, the exit by CalPERS – and the public debate swirling around the investment expenses associated with hedge funds – has forced some hedge funds to reconsider their fee structures. From the Wall Street Journal:

Two titans of the hedge-fund and private-equity world say they are growing more open to reducing fees in the face of rising scrutiny of the compensation paid to managers of so-called alternative investments.

[…]

Mr. [John] Paulson [founder of hedge fund firm Paulson & Co.] said he feels “pressure” to act in the wake of “enormous numbers in compensation” for hedge fund managers. Mr. Paulson, 58, earned a reported $2.3 billion last year, counting both fees and the appreciation of his own personal investment in his funds.

“Institutions are becoming a little more demanding…they are putting pressure on the management fee and the incentive fee,” he said Monday during a panel discussion at New York University’s Stern School of Business.

Joseph Landy, co-CEO of $39 billion buyout shop Warburg Pincus, echoed Mr. Paulson’s experience.

“There are a lot of private-equity managers out there who can make a lot of money before they return a dime to investors,” Mr. Landy said. “Most of the pressure [to reduce fees] has been on the actual annual management fee.”

Neither he nor Mr. Paulson, however, were too concerned about any widespread threats to their businesses.

“We came out relatively unscathed from the crisis. We’re doing pretty much the same things we did as before [with] very little restrictions on how we invest the money,” Mr. Paulson said.

Paulson said he think more hedge funds will start using “hurdles”, a fee structure which prevents managers from collecting performance fees until they’ve met a certain benchmark return.

Photo by Stephen Curtin

Chart: The Rise of Hedge Funds In Pension Portfolios

In recent years, hedge funds have solidified themselves as a big part of pension portfolios by two measures:

1) More pension funds than ever are investing in hedge funds

2) Those pensions are allocating more money towards hedge funds than ever before

That bears itself out in the above graphic, and this next one:

A recent Preqin report had this to say about the numbers:

“There are more US public pension funds than ever before allocating capital to hedge funds, and these investors are investing the most they ever have in the asset class. Public pension funds have increasingly recognized the value of hedge funds as part of a diversified portfolio, and although CalPERS’ withdrawal from the asset class will spark some investors to look more closely at their current allocation model, the importance of hedge funds as a source of risk-adjusted returns for these investors is likely to continue to prove attractive for US retirement schemes.

Preqin’s recent research highlights that investors are not using hedge funds to produce outsized returns, but instead to produce uncorrelated, risk-adjusted returns. Over short and longer time frames, hedge funds have in general met investor needs for risk-adjusted returns. However 2014 has been a period of relatively turbulent returns when looking at Preqin’s monthly benchmarks; in times like this, investor calls for changes in fee structures and better alignment of interests become more vocal, and this clearly has had an impact on CalPERS’ decision.”

Chart Credit: Preqin

Interview: Hedge Fund Mogul Talks CalPERS’ Pullout, Manager Selection and Justifying Fees

Forbes released an interview Thursday morning with Anthony Scaramucci, founder and co-managing partner of alternatives investment firm SkyBridge Capital.

The interview touched on CalPERS’ hedge fund exit, how the pension fund picked the wrong managers and how to pick the right ones. Later, Scaramucci touched on justifying the industry’s fee structure.

On CalPERS’ pullout:

Steve Forbes: Thank you, Anthony, for joining us. To begin, in terms of hedge funds, as you know the overall performance of hedge funds has lagged the market in recent years. CalPERS, the largest hedge fund in the country, made headlines by saying, “We’re getting out of this.” What is that a sign of? Either the hedge fund industry is going away and is only sustained because there’s nothing else around that’s suppressing interest rates or is this a sign of the bottom? When a big one gets out does that mean this is the time to get in?

Anthony Scaramucci: Well, so, the question’s is it going to get easier or harder from here? That was a good start, Steve. But the short answer is that there’s a lot of reasons why the industry’s underperformed. The main one has to do with something you often talk about, which is Federal Reserve monetary policy.

So, the policy since March of 2009 has been to hammer down the rates, artificially stimulate the market. This makes it impossible for about 40% of the hedge fund managers to perform. If you look at the overall hedge fund manager index, 40% of it is in long-short managers.

And so if you’re long something, you’re doing great in this market. But I’ve got to tell you something, Steve. If you’re short something, even if you’re right on the security analytics, you’re going to be wrong on the momentum of the market. And so what’s happened to the long-short managers is the longs are going up, the shorts are going up, and they have this little tight spread. They’re making 3%, 4%, 5% when the market’s rip roaring and the media is writing all these nasty articles about them.

But there are places to make money. There’s structured credit, activism. There’s a whole host of distressed guys that have done well over the last six years. But I think the media has been justified in pointing out that, in general, the hedge funds have not done well.

The CalPERS thing is a little different. They only had 1.5% of their assets there. Joe Dear, who was a legendary guy at CalPERS, when he passed I think it became one of those things where they weren’t going to get bigger for political reasons, and so they decided to get way smaller. But I don’t think it’s a death knell of the industry yet. In fact, I’ll make a prediction that we’ll look back two or three years from now and say that they caught the bottom of the hedge fund performance market.

On manager selection:

Forbes: You said that they [CalPERS] picked the wrong hedge fund managers.

Scaramucci: Yes.
Forbes: How do you pick the right ones? Because it’s fine to say, “Well, if you look at the top 10%, you would have done nifty.”

Scaramucci: Yes.

Forbes: But, like, the top 10% of stocks, how do you do it on a consistent basis?

Scaramucci: Well, okay. So, not to use a baseball analogy, but just think of it this way.

Forbes: You can, I’m a fan.

Scaramucci: Okay. So, well then you’ll probably know this from the Bill James Abstracts. Sixty percent of the everyday players are batting .260 or below, yet every midsummer classic we see 40 guys on the field that are Hall of Famers or the top of what they do. And I think that’s indicative of most industries, frankly, whether it’s the media, the hedge fund industry or, you know, political landscape and so forth. And so there are certain metrics that you can use to identify who’s going to do well. But the number one metric is the macro environment.

If you tell us what the economic dashboard looks like over the next 12 to 18 months, we have pretty high capabilities on the prediction side of what sectors are going to do well. As an example, 2009, if you and I were having this conversation, I would have told you that the residential mortgage-backed security market was going to do very, very well. Those assets were distressed. They were technically oversold by the large institutions. The Federal Reserve monetary policy at that time with Helicopter Ben bringing things down so aggressively, that was going to be an easy place to make money.

And so if you looked at SkyBridge at that period of time, we had about 45% of our assets there. So, the first factor is the macroeconomic factor. The second factor then is, once you figured out what sector you’re going to be in, who are the best guys in that sector and why are they the best? And frankly, a lot of them will be different depending on different markets. Some guys are longer than others. They’ll always be longer. Lee Cooperman is an example of that. If you’re a bull on the market, Lee’s a good bet. It’s that sort of thing.

On the fee structure of hedge funds:

Forbes: You’re a fund of funds, so to speak.

Scaramucci: Yes. Yes.

Forbes: And you know the rap, hedge funds 2%, 20%.

Scaramucci: Sure.

Forbes: Now your fees 1.5%, whatever it is, on top of that.

Scaramucci: Yes. Yes.
Forbes: How do you justify your existence?

Scaramucci: Well, listen. We’re up there with child molesters with most people, so I’ve got a hard time in justifying my existence at times. But I tell people the same thing that I think you would tell them if you were in my seat. Focus on net performance.

If you’re worried about fees, well then you certainly shouldn’t be in the hedge fund industry. But I think what we’ve proven, if you look at our long-term track record, we can help clients get to their actuarial goals by taking less risk, or less beta, if you will.

And so our performance is high single-digit, low double-digit over the last ten years with relatively low volatility. And so I think we’ve been able to justify that. But we did shift our model. I often talk about hedge fund fund of funds 3.0 in the sense that we’re viewing ourselves more like a multi-strat now. We look at the macro environment rather than trying to hug the index, like some of our peers.

The typical fund of funds got a bad rap because they weren’t doing the due diligence. And then they give you 50 managers. They’d give you a 2% in each of those managers. And you’d be hugging the index on your way to mediocrity. What we’ve tried to do, is we’ve tried to concentrate our portfolio on things that we think are working. We have a dynamic approach, where we will move out of securities or move out of hedge funds quickly if we think the market environment has changed. And we believe in concentration.

So, the top ten managers for us, Steve, are about 65% of the assets. And I think that’s differentiated us from our peer group. One last point, if you don’t mind me making it is that, if I’m giving a billion dollars out to somebody, if SkyBridge is giving out a billion dollars, we’re asking for fee concessions. And so we pass those on to our investors. So, even though we have all these loaded fees, so to speak, we’re giving back 75, 80 basis points a year in fee concessions, which I think is meaningful.

The entire interview can be read here.

Update: Naked Capitalism vs. CalPERS

Last winter, Susan Webber, who runs the financial blog Naked Capitalism, filed a public records request with CalPERS seeking the fund’s private equity return data. According to Webber, CalPERS didn’t fulfill the request – and so Webber filed a lawsuit to get it.

After a few months of back-and-forth, CalPERS said last week it had given Webber the data she requested. But Webber, in a post over the weekend, says otherwise. From Naked Capitalism:

To update you on the state of play with CalPERS: since we received some financial data in February and March, CalPERS has engaged in foot-dragging. Even though CalPERS said in court filings that it stood ready to provide the data we sought, it has failed to do so. For instance, CalPERS’ Deputy Executive Officer for External Affairs, Robert Glazier, promised in mid April that he would send an important missing spreadsheet the following week. More than six months have passed and CalPERS has yet to provide it.

We have three types of data we are seeking: the spreadsheet mentioned (CalPERS has provided an 627 page image, but under California’s version of FOIA, they are required to provide machine-readable records in data form, but continue to fail to comply), commitment dates (CalPERS has consistently ignored this request) and detailed cash flows (of which CalPERS has only provided partial information; by our count, we are still 351 funds short). So of three requests, for two we have yet to receive any information, and for the third, we have received only partial information.

You can read more about the lawsuit and the FOIA results here. CalPERS’ response to Webber’s blogging can be read here.

Photo by Stephen Curtin

The Ten Pension Funds Getting Best Private Equity Returns

A new report from Bison and the Private Equity Growth Capital Council (PEGCC) ranked the ten pension funds seeing the best private equity returns over the last decade.

[List can be seen above.]

CalPERS Reprimands Two Board Members for Campaign Finance Violation, Bashing CIO

Two CalPERS board members were punished yesterday; one for failing to disclose campaign finance documents and the other for publicly criticizing the fund’s chief investment officer.

One board member, J.J. Jelincic, was instructed to stop speaking to the press after he publicly criticized CalPERS’ new chief investment officer, Ted Eliopoulos. Writes the Sacramento Bee:

“He doesn’t have the temperament or the management skills,” Jelincic said in a Sept. 29 Pensions & Investments story about the hiring [of the fund’s new CIO].

And he didn’t stop there. Eliopolous played favorites with staff, Jelincic said, listened too much to outside consultants and made poor investment decisions.

CalPERS board President Rob Feckner called the comments “unfortunate and a breach of board governance policy of civility and courtesy as well as a breach of the CalPERS core values.” Jelincic was then instructed to stop talking to the media.

After the board meeting, Jelincic told the media:

“I’m not sure what the hell it meant other than they didn’t want me talking to the press.” As for the statements he made about Eliopoulos, he added: “It was a comment on a public action.”

The other reprimanded board member, Priya Mathur, was stripped of several leadership positions on Wednesday after repeatedly failing to disclose campaign finance disclosures. From the Sacramento Bee:

Priya Mathur, a board member since 2003, was removed as board vice president and chair of the CalPERS Pension and Health Benefits Committee. She also is out as vice chair of two committees: Board Governance and Performance, Compensation & Talent Management.

Mathur, who is facing a $4,000 fine from the state Fair Political Practices Commission, sat stoically as CalPERS board President Rob Feckner announced the punishment at a board meeting. She didn’t speak and wasn’t available for comment afterward.

[…]

The FPPC is fining Mathur for failing to file four campaign finance statements in connection with her recent successful bid for re-election to the CalPERS board.

She had no campaign funds to report, and Mathur has previously described the issue as a paperwork snafu. Nonetheless, “we still believe that rules are rules,” Feckner said.

Mathur has been fined $13,000 by the FPPC during her tenure as a board member. She failed to make necessary disclosures in 2002, 2007, 2008, 2010, 2012 and 2013.

CalPERS CEO Addresses Stockton Ruling

Anne Stausboll, CEO of the California Public Employees Retirement System, released a statement addressing a recent court ruling that the bankrupt city of Stockton could cut pensions and stop contributing to CalPERS as part of its bankruptcy proceedings.

The statement in full:

The ruling last week by a federal bankruptcy judge in Stockton’s bankruptcy case has caused many to speculate about the future of pensions. Public employees, retirees, employers, lawyers, taxpayers, and journalists have legitimate questions and concerns.

As the administrator of pensions, the California Public Employees’ Retirement System does not win or lose in this situation. If pensions are reduced in bankruptcies, the only losers are public employees.

Contrary to the belief of many pension critics, CalPERS is no Goliath. Franklin Templeton Investments – the last bondholder standing in the way of the city of Stockton’s plan to rebuild – is no David.

Franklin Templeton is a sophisticated Wall Street investor that did its due diligence, analyzed the risks, and decided to make a $36 million investment in Stockton. As it turns out, the investment did not pay off. That’s how the investment world works. Franklin needs to move on.

The real Davids are the current and former employees of the city of Stockton whose retirements are at stake. These librarians, secretaries, firefighters, police officers, 911 dispatchers, and school custodians chose to serve the public at lower salaries in return for the promise of a reliable and secure pension. Their pensions are deferred compensation that they earned by working 10, 20, and sometimes 30 years in service to their communities.

Public employees contribute from every paycheck toward their own retirement. It is not a bonus or optional benefit that an employer may choose to not pay during hard times.

We applaud the leadership of Stockton officials in finding solutions to protect the pension promises made to its public employees while forging a reasonable path toward a fiscally sustainable future.

CalPERS will stand by Stockton, its employees, and residents, and will continue to champion those who really stand to lose – the real Davids – the public employees and retirees who spent their careers serving our communities and California.

Photo by Stephen Curtin

CalPERS, Other Major Funds To Bid On Bankrupt Indiana Toll Road

CalPERS, the Canada Pension Plan Investment Board and other large funds from around the world are lining up to bid on an Indiana toll road that filed for bankruptcy last month.

The toll road is operated by a private company, ITR Concession Co LLC.

From Reuters:

The interest in the asset shows that infrastructure investors have not been fazed by the failure of one of the largest privatisations of U.S. infrastructure, even though any deal is expected to come at a significant discount to its original value.

Canada Pension Plan Investment Board (CPPIB) has teamed up with Ferrovial SA’s toll road operator Cintra and Canadian investment manager Brookfield Asset Management to make an offer, the people said this week.

Australia’s Hastings Funds Management has partnered with the California Public Employees’ Retirement System (Calpers) and Italian toll road operator Autostrade Meridionali SpA , the people said.

Spanish infrastructure operator Abertis Infraestructuras SA has teamed up with Borealis, which is the infrastructure investment arm of the Ontario Municipal Employees Retirement System, the people said. Australian infrastructure fund manager IFM Investors is also leading its own consortium, the people added.

The composition and number of the consortia could still change, the people said. Alberta Investment Management Corporation (AIMCo) and Abu Dhabi Investment Authority (ADIA) have considered joining the race but have yet to make a decision, some of the people said.

Sources told Reuters that the price tag will likely wind up somewhere between $4 billion and $5 billion.

Indiana leased the toll road out to ITR Concession Co for 75 years in 2006. In return, the state received $3.8 billion.

CalPERS Weighs Foray Into Riskier Loan Securities

CalPERS is considering investing in collateralized loan obligations (CLOs), or securities backed by a pool of (sometimes low-grade) corporate loans.

From the Wall Street Journal:

Fixed-income executives for the nation’s largest public pension fund told their investment board committee Monday they want to buy riskier versions of “collateralized loan obligations,” which are securities backed by corporate loans. The plan already invests in triple-A rated slices of these securities.

“We think we have expertise in this area,” said fixed-income head Curtis Ishii. He added: “You get more spread if you take more risk.”

Mr. Ishii did not disclose how much the system, which is known by its abbreviation Calpers, would like to invest in the riskier loan-based securities. The move still needs to be approved by an investment strategy group comprised of the fund’s top investment officers.

Any shift it makes will likely influence others because of its size and history as an early adopter of alternatives to traditional stocks and bonds.

CalPERS announced last week that it is increasing its real estate holdings by 27 percent.

Photo by Stephen Curtin

Chart: Comparing CalPERS to the Endowment Index

The Endowment Index represents the asset allocation and returns of the world’s largest institutional investors.

The this chart [above], you can compare the asset allocation and 10-year returns of CalPERS to other massive institutional investors. This chart represents CalPERS’ allocation before its hedge fund exit, which is an ongoing process.