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CalPERS To Measure, Disclose Carbon Footprint of Portfolio

CalPERS and several other institutional investors signed the Montreal Carbon Pledge yesterday. The pledge mandates that the investors measure and publicly report the carbon footprint of their entire investment portfolio.

Pennsylvania Not Cutting Hedge Funds Despite State Auditor’s Skepticism

CalPERS’ decision to pull out of hedge funds is having a ripple effect across the country.

On Wednesday, Pennsylvania Auditor General Eugene DePasquale released this skeptical statement on the state pension system’s hedge fund investments:

“Hedge fund investments may be an appropriate strategy for certain investors and I trust that SERS and PSERS weigh investment options carefully,” DePasquale said in a statement. “But, SERS and PSERS are dealing with public pension funds that are already stressed and high fees cost state taxpayers more each year. I support full disclosure of hedge fund fees paid by our public pension funds and we owe it to taxpayers to ensure that those fees do not outweigh the returns.”

Spokespeople for both the State Employees Retirement System (SERS) and the Public School Employee Retirement System (PSERS) have now responded. The consensus: the pension funds will not be cutting their hedge fund allocations.

From Philly.com:

SERS has no plans to cut hedge funds further. “Hedge funds play a role in our current board-approved strategic investment plan, which was designed to structure a well-diversified portfolio,” SERS spokeswoman Pamela Hile told me. With many more workers set to retire, hedge funds (or “diversifying assets,” as SERS prefers to call them) combine relatively steady returns with low volatility “over varying capital market environments.” By SERS’s count “difersifying assets” are now down to $1.7 billion, or 6% of the $28 billion fund and returning 10.7% after fees for the year ending June 30, up from a 10-year average of 7.4%.

Says PSERS spokeswoman Evelyn Williams: “We agree with the Auditor General that hedge funds are appropriate for certain investors. Not all investors can or should invest in hedge funds. Clearly CALPERS reviewed their hedge fund allocation and acted in their own fund’s best interests.

“PSERS also sets our asset allocation based on our own unique goals and issues. We do not have any immediate plans to change our hedge fund asset allocation at this time… PSERS’ hedge fund allocation provides diversification for our asset allocation and is specifically structured so it does not correlate with traditional equity markets…PSERS hedge fund allocation has performed as expected and provided positive investment returns over the past fiscal year, one, three, and five years.”

SERS allocates 7 percent of its assets, or $1.9 billion, towards hedge funds. PSERS, meanwhile, allocates 12.5 percent of its assets, or $5.7 billion, towards hedge funds.

Photo by TaxRebate.org.uk

CalPERS Is Ramping Up Its Real Estate Portfolio. Why?

Last week marked a big shift in investment strategy for CalPERS, and it goes beyond hedge funds. The pension fund’s hedge fund pullout got all the headlines, of course, but CalPERS also decided to invest an addition $1.3 billion in real estate.

The reasoning behind dropping hedge funds has been made clear. But what about the real estate investments? Over at GlobeSt.com, Erika Morphy explores some of the reasons that could be behind CalPERS’ deep dive into real estate.

From GlobeSt.com:

It’s business as usual

It was just real estate’ turn, says Stephen Culhane, who heads the investment management practice at the law firm Kaye Scholer.

“Institutional investors are always assessing and reassessing their allocations,” he tells GlobeSt.com. “Commercial real estate valuations are strong and it is perceived as a bit as a safe haven particularly for non US and long-term investors.”

It’s a shift in investment philosophy – and not just a change in asset allocation

CalPERS handles over $300 billion for over 1 million current and former state employees. Their investing philosophy is transitioning from a classic hedge fund, 60/40 model, to more of an endowment model, says Jeff Sica, founder and CIO of Circle Squared Alternative Investments.

“CalPERS is aiming to reduce volatility and obtain a more predictable annual return across their portfolio,” Sica tells GlobeSt.com. “Their move into real estate provides them with stability and a quantifiable income stream. With reduced volatility and a stabilized annual return, it will be more beneficial to them in the long run instead of fluctuating with the equity market,” he says.

Hedge funds have lost their appeal.

Despite CalPERS careful explanations, this is the theory of Bill Militello, co-founder and CEO of Militello Capital.

“The increasing trend of moving away from hedge funds is due in part to their lack of transparency and a lack of understanding of the investments—they are intangible,” he tells GlobeSt.com. “Hedge funds are simply public securities in a different wrapper, they are not an asset class, they are a compensation scheme.”

There is also evidence that hedge funds on an overall basis have actually underperformed versus passively managed funds, Chauncey M. Swalwell, partner with Stroock & Stroock & Lavan LLP, tells GlobeSt.com—”making the relatively high fees typically paid to hedge fund managers untenable at CalPERS.”

It is an inflation hedge

This is the flip side of fund’s decision, Militello adds. “Properly purchased real estate in supply constrained markets with built in demand drivers provides access to well-insulated investments that protect against rising interest rates.”

There isn’t space here to list all the potential reasons listed. You can read all seven reasons here.

LACERS also committed an additional $190 million to real estate investments last week.

Public Pension Funds Drive Venture Capital Boom, But Performance Is An Issue

The venture capital industry is becoming a major force again, and pension funds are the major driver of the resurgence. From Businessweek:

Public pension funds—the state-run investment pools responsible for the retirement benefits of nearly 20 million Americans—have quietly been funding the recent boom in venture capital. The investment pools are made up of tax dollars and contributions from state employees. For the last few years, they have made up the biggest single source of funds flowing to venture capital, according to the most recent Dow Jones Private Equity Analyst Sources of Capital survey. In 2014, they contributed 20 percent of the sector’s overall haul, down slightly from a 25 percent contribution in 2013.

Indiana’s Public Retirement System allocates (PDF) 1.6 percent ($363 million) to venture capital, which is on the higher end as a percentage of assets; the California Public Employees’ Retirement System (CalPERS) allocates a more typical half percent of assets, although the fund is so big that this meager fraction totaled $1.8 billion in 2013. The amounts are small enough that if pension funds’ entire venture capital investments were to evaporate, pensioners would still be all right. In most states, pension obligations are guaranteed by state constitutions. If the investments—in venture capital or anything else—don’t pay off, taxpayers are on the hook for the shortfall.

But there’s a problem: some of the best venture capital funds don’t want to do business with public pension funds. From Businessweek:

Because public pensions must be transparent about their investments, which are subject to the Freedom of Information Act, many top-performing venture capital funds won’t accept pension money; they don’t want to publicly disclose their portfolios. This makes public pensions pick from other—often lesser-performing—funds.

Like hedge funds and other kinds of private equity, venture capital funds charge an annual management fee of 2 percent, plus 20 percent of profits. Performance is an open question. Many funds fail to perform (PDF) as well as an Standard & Poor’s 500-stock index fund. Diane Mulcahy,senior fellow at the Kaufmann Foundation, has observed that many venture capital funds aren’t profitable and that steady fee income diminishes the funds’ incentive to find profitable investments.

Other institutional investors are funding the VC resurgence, as well. Endowment funds provided the VC industry with 17 percent of its capital in 2014, according to the Dow Jones survey. Corporate pension funds accounted for 7 percent, while union pension funds accounted for 2 percent.

Photo by c_ambler via Flickr CC License

5 Potential Outcomes Of CalPERS’ Hedge Fund Pullback

The last week has seen a flurry of debate of what CalPERS’ hedge fund divestment actually means in the bigger picture.

Is this an instance of just one fund shifting its investment strategy? Or is it emblematic of a larger, accelerating trend?

At FinAlternatives, the founder of a hedge fund marketing firm has weighed in on the potential outcomes of CalPERS’ decision. Don Steinbrugge writes:

Agecroft Partners believes we will see the following 5 outcomes:

1. Continued pressure on hedge fund fees for large mandates

Over the past 5 years there has been a strong trend of hedge funds increasingly offering fee breaks for large pension funds and the clients of institutional consulting firms. These fee breaks began with a discount on management fees only, but now often includes performance fees. Fee breaks vary by manager, but for a typical hedge fund with a 2 and 20 fee structure the discount is often 25% off standard fees…

2. Pension funds will continue to increase their allocation to hedge funds

The average public pension fund will continue their long term trend of increasing their allocation to hedge funds in order to enhance returns and reduce downside volatility of their portfolio…

3. More focus on smaller hedge fund managers

In a study conducted from 1996 through 2009 by Per Trac, small hedge funds outperformed their larger peers in 13 of the past 14 years. Simply put, it is much more difficult for a hedge fund to generate alpha with very large assets under management…

Steinbrugge writes much more over at the link, here.

Steinbrugge is the Founder and Managing Partner of Agecroft Partners, a global hedge fund consulting and marketing firm.

Professor: Pension Funds Need To Rethink Manager Selection

A few hours after news broke of CalPERS cutting ties with hedge funds entirely, one anonymous hedge fund manager opined: “I think it’s not hedge funds as an asset class [that are underperforming]. It’s the ones they invest in.”

But was it really manager selection that was the root cause of CalPERS’ disappointment with hedge funds? Dr. Linus Wilson, a professor of finance at the University of Louisiana, thinks so.

Particularly, he thinks pension funds are ignoring data that suggests newer, smaller managers perform better than the older, larger hedge funds that pension funds typically prefer. He writes:

CalPERS and other institutional investors such as pensions, endowments, and sovereign wealth funds have ignored the wealth of data suggesting that their manager selection criteria is fatally flawed. Hedge Fund Intelligence estimates that on average hedge funds have returned 3.7% year to date. Yet the S&P 500 (NYSEARCA:SPY) has returned over 8% over that period.

Most institutions and their consultants implicitly or explicitly limit their manager selection criteria to hedge funds with a multi-year track record (three years or more) and assets under management in excess of $250 million. The AUM screen is probably higher; $1 billion or more. Unfortunately, all the evidence shows that choosing hedge funds with long track records and big AUM is exactly the way to be rewarded sub-par returns.

A recent study by eVestment found that the best absolute and risk-adjusted returns came from young (10 to 23 months of performance) and small (AUM of less than $250 million) hedge funds. My anecdotal evidence is consistent with this fact. My young and small fund, Oxriver Captial, organized under the new JOBS Act regulations, is outperforming the bigger more established funds.

More data on the performance of newer hedge funds:

One study eventually published in the top-tier academic journal, the Journal of Financial Economics, found that, for every year a hedge fund is open, its performance declines by 0.42%. The implication is that hedge fund investors should be gravitating to the new managers if they want high returns. Yet another study by Prequin found that even when established managers launch new funds, those funds underperform launches by new managers.

The Prequin study found that managers with three years or less of track record outperformed older managers in all but one of seven strategy category. The median strategy had the new managers beating the older ones by 1.92% per annum. Yet, that same study found that almost half of institutional investors would not consider investing in a manager with less than three years of returns.

Pension funds have repeatedly justified forays into hedge funds by pointing out the potential for big returns, as well as the portfolio diversification hedge funds offer.

Dr. Wilson doesn’t deny those points. But to truly take advantage of hedge funds, he says, pension funds need to rethink their approach to manager selection. That means investments in smaller, newer hedge funds.

Blackstone Backs CalPERS Hedge Fund Pullout

Blackstone was one of the investment firms that helped CalPERS get its start in hedge funds over a decade ago. But the firm’s president, Tony James, told a crowd at a private equity event on Thursday that he supported the pension fund’s pullback from hedge funds. From Chief Investment Officer:

Speaking at a private equity event in New York yesterday, James said CalPERS’ move was “wise” given the poor returns generated by the allocation, dubbed “Absolute Return Strategies” (ARS) by the pension.

He added: “A lot of people think about hedge funds as a way to get higher returns. Hedge funds are a way to play the stock market with somewhat lower volatility and somewhat lower returns. You don’t expect hedge funds to get shoot-the-lights-out returns. You save that for private equity and for real estate.”

CalPERS hired Blackstone in 2001 to invest $1 billion in hedge funds.

Over the past 10 years, the pension fund’s hedge fund portfolio produced annualized returns of 4.8 percent, according to Bloomberg.

CalPERS Sticking With Commodities After Considering Pullback

CalPERS is not exiting commodities, a fund spokesman said this week, although it had slashed its commodities portfolio earlier this summer. CalPERS’ complete pullback from hedge funds made some observers wonder whether other allocation shifts were on the horizon.

But for now, the fund says its commodities investments will continue as planned. From Reuters:

The $300 billion Calpers…has maintained a portfolio of commodity futures tied to the S&P GSCI since 2008.

[…]

“This [hedge fund] decision does not impact … commodities, or any other program, at Calpers,” he said in an email, referring to Calper’s decision to pull out of hedge funds entirely.

Some of the hedge funds on Calpers list may have commodities exposure and dropping them could indirectly affect sentiment in the sector, investment advisers said.

[…]

The Calpers’ commodities portfolio has fluctuated in value since its 2008 inception, due to both the performance of the S&P GSCI and portfolio adjustments made by Calpers.

From $1.4 billion at end-June 2008, it plunged nearly 60 percent in value over the next year to around $600 million after the financial crisis. After rising to $700 million in 2010 as commodity markets rebounded from the crisis, the portfolio suddenly rocketed in value, reaching a high of $3.2 billion at end-June 2012, apparently from new money channeled by Calpers.

But as commodity markets struggled again in 2013 and Calpers realized little earnings from the investment, it slashed the portfolio, bringing it to $1.3 billion by June this year, a preliminary report for 2014 showed. Much of the funds were diverted to inflation-linked bonds, Calpers data showed.

Reports had surfaced back in August that CalPERS was seriously considering cutting back its commodities investments. The Wall Street Journal wrote:

One of the more-dramatic moves under consideration is a complete pullback from tradable indexes tied to energy, food, metals and other commodities, according to people familiar with the discussions. Calpers began making such investments in 2007 as a way of diversifying its portfolio…

[…]

The discussions are taking place between the fund’s interim Chief Investment Officer Ted Eliopoulos and Calpers’s other top investment executives. The Calpers board hasn’t yet been informed about any possible changes and no final decisions have been made, the people said.

Obviously, CalPERS never pulled the trigger on a commodities exit. But the fund has shown a willingness to quickly shift its investment policy and a preference for low-cost investments.

Is Now the Time For Pension Funds To Push Back On Fees?

CalPERS cut ties with hedge funds because, among other reasons, the fees associated with those investments.

Some money managers and pension fund staff are saying that now is the perfect time for other pension funds to speak up about their aversion to fee-heavy investments. The managers told Reuters:

“Pension funds and everyone else would be remiss not to push on fees now,” said Brad Balter, Managing Partner of Balter Capital Management, which invests in hedge funds and is now offering its own liquid alternatives fund that mimic hedge fund performance with a lower fee structure.

[…]

Joelle Mevi, who has long been arguing for lower fees, first as chief investment officer at New Mexico’s pension fund and now as executive director and CIO at the City of Fort Worth’s pension plan, agreed that Calpers’ move could be a wakeup call.

“Top hedge fund managers could see that this is a trend and it could strike fear in their hearts,” she said.

Hedge funds reached by Reuters declined to comment. But the industry has in the past rebuffed criticism over fees and performance by saying returns tend to outperform when markets fall. It has also pointed to strong demand: hedge funds which manage $3 trillion attracted $30.5 billion in new money during the second quarter alone.

Stephen Nesbitt, who runs consulting firm Cliffwater LLC and works with prominent pension funds, said hedge fund performance, like stock performance, can vary greatly – underscoring the need for investors to make careful choices.

“There are many investors who are happy with the results. It works for some and it has to do with implementation,” he said.

It’s not out of the ordinary for pension funds to negotiate with hedge funds on the matter of fees. The Massachusetts Pension Reserves Investment Management Board (PRIM) was doing exactly that even before the CalPERS news came out. From Reuters:

Massachusetts, which invests roughly $5.6 billion with hedge funds, is pushing to move some of that money into separately managed accounts and may even invest, at a lower cost, in liquid alternative strategies.

“Moves by the big leading pensions like Calpers only reaffirms liquid alternatives are the wave of the future,” said Brad Alford, chief investment officer at Alpha Capital Management, which has put money into hedge funds and also now offers liquid alternative funds.

“Smart investors are no longer willing to pay these high fees for single digit returns,” Alford said. “High fees, little transparency, limited liquidity, light regulation plus hard to measure risk from leverage and derivatives are not a good investment solution.”

The Los Angeles Fire & Police Pension System chose to drop hedge funds long before CalPERS made headlines; they made the move early this summer when they removed $550 million from hedge funds.

Photo by www.SeniorLiving.Org

Rhode Island, Raimondo Defend Hedge Fund Position After CalPERS Pullout

Rhode Island’s pension fund invests nearly $2 billion in hedge funds, or 14 percent of its overall portfolio.

In light of CalPERS high-profile pullback from hedge funds, The Providence Journal asked Gina Raimondo, Rhode Island’s Treasurer, for her thoughts on CalPERS’ decision and the fate of hedge funds in Rhode Island’s portfolio:

State Treasurer Gina Raimondo sees no immediate reason to pull Rhode Island’s pension money out of hedge funds, just because the largest public pension fund in the U.S. – the California Public Employees Retirement System – has announced plans to do so over the next year.

[…]

Asked Tuesday if Rhode Island would take its cue from Calpers, Raimondo chief of staff Andrew Roos said: “We will continue to learn from best practices around the country and will look closely at the CalPERS decision.’’

But he said: “Rhode Island’s pension fund is less than 3% the size of Calpers and has very different funding and cash-flow needs. Given our fund’s different characteristics, we will continue to pursue strategies that pursue the best outcomes for Rhode Island pension participants.’’

Roos acknowledged that the state’s hedge-fund-heavy strategy brings loads of fees. He also admitted that the hedge funds have under-performed in 2013 compared to the rest of the pension fund’s portfolio. But he stood by the investments. He told the Providence Journal:

“Every action the State Investment Commission has taken during this administration has been to promote retirement security and ensure funds will be available to pay pension checks to our retirees,’’ he said.

“After the financial collapse of 2008-2009 when the fund lost over $2 billion dollars, the SIC reviewed its policies and unanimously adopted a plan to reduce volatility while continuing to pursue strong long-term returns … As a part of the strategy to reduce volatility while maintaining strong long-term returns, the SIC improved the pension fund’s diversification, which included making allocations to hedge funds….’’

“This strategy is working,’’ Roos said. “Over the last three years we have reduced the volatility of this portfolio by 50% and achieved strong returns (1 year: 15.12%; 3 year: 9.05% as of June 30, 2014) … [But] like every other investment the state makes, the SIC and staff are constantly evaluating and making adjustments to the hedge fund allocation to ensure it is performing as intended.’’

Rhode Island’s pension fund paid $70 million in investment fees in the 2012-13 fiscal year. Meanwhile, the state’s hedge fund investments returned around 8.8 percent in 2013-14, while the pension fund’s overall portfolio returned 15 percent over the same period.

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