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CalPERS Weighs Withdrawal From Commodities

California is often on the cutting edge of trends that eventually reverberate throughout the rest of the country. The same is true of CalPERS, the pension fund that was among the first to invest in real estate, hedge funds and private equity.

So when CalPERS announces a dramatic change in investment strategy, other funds drop what they’re doing and listen. Funds are certainly listening lately, as CalPERS is considering a handful of moves that would shift its asset allocation significantly.

Among them: the fund is considering taking all of its money out of commodities. From the Wall Street Journal:

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 and it currently has $2.4 billion in such derivatives, or less than 1% of total holdings.

[…]

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.

The move, however jarring, wouldn’t be out of step with other recent investment decisions by CalPERS. The fund has shown a willingness to exit large investments it considers risky. From Wall Street Daily:

CalPERS’ potential retreat from riskier investments is evidence that it’s trying to simplify its portfolio and guard against losses during the next market downturn.

In a sense, CalPERS is turning to a bit of a “risk off” mode in this time of uncertainty.

Ultimately, with the realization that we’re in the midst of the Fed’s continued tapering, talk of interest rates hikes, and geopolitical unrest from the Middle East to the Ukraine, it may be time to dial down risk and play it safe.

In fact, this move is reflective of last fall, when CalPERS hinted at a shift away from complex investments, warning that the fund “will take risk only where we have a strong belief we will be rewarded for it.” This decision came after it had approved a new set of investment goals that reduced future exposure to equities and private equity, while increasing allocations to bonds and real estate.

A similar move by CalPERS also took place at the end of 2012, when the fund chopped commodities investments by more than half – prompting reports that it was shifting from commodities to inflation-linked bonds.

And in both incidences, the commodities markets experienced corrections.

CalPERS is weighing several other ideas, including whether forgo individual stocks in favor of securities that track broader industries.

CalPERS also made headlines last month when it announced it would cut its hedge fund allocation by 40 percent.

Photo by Terence Wright via Flickr CC License

As Some Pension Funds Phase Out Hedge Funds, Others Phase Them In

There were big headlines earlier this month when CalPERS announced its decision to chop its hedge fund allocation by 40 percent. The news was big not just because it was CalPERS, but because the decision followed in the wake of similar decisions made by smaller funds around the country.

The Los Angeles Fire & Police Pension System might not be a mammoth like CalPERS, but it was still a big deal when the $18 billion fund decided to phase out hedge funds entirely. The fund says it will save around $13 million in fees annually as a result of the decision, which re-allocated $550 million from hedge funds into other asset classes.

“We need to show that we are willing to walk away from managers that are charging us exorbitant fees,” Emanuel Pleitez said in a video interview with Pensions & Investments.

But it’s not just fees. Past experiences inform future investments, so when the Louisiana Firefighters Pension Fund drastically chopped its hedge fund allocation, it was hard to blame them.

That’s because the Firefighters Fund in 2008 had made a $15 million investment in Fletcher International Ltd, a Cayman Islands-based hedge fund.

Sometime in 2012, Fletcher stopped picking up their phone. The Firefighters later found out that was because Fletcher had gone bankrupt. Just like that, they’d lost 100 percent of their $15 million investment.

As a result, the Firefighters Fund reduced its hedge fund investments by nearly 90 percent. Now, only 0.6 percent of the fund’s assets are dedicated to hedge funds, according to Pensions & Investments.

Anecdotal evidence aside, there’s very little indication the movement away from hedge funds is a larger trend.

In fact, if there is a trend, it may be moving towards more hedge fund investments, not fewer. Sticking with anecdotes for a moment, Pensions & Investments reports that a handful full of pension funds are looking to make their first foray into hedge funds:

Among recent first-time hedge fund investors and searchers:

-Illinois State Universities Retirement System, Champaign, will soon begin a search for either hedge fund or fund-of-funds managers for a new 5% allocation for the $16.9 billion defined benefit plan it oversees;

-The $5.1 billion City of Milwaukee Employes’ Retirement System hired Allianz Global Investors to manage $62.5 million in an absolute-return strategy in July;

-The $1.1 billion St. Paul (Minn.) Teachers’ Retirement Fund Association hired EnTrust Capital Management LP to manage $55 million in a customized hedge fund-of-funds separate account in May.

A recent survey revealed that institutional investors are planning on increasing their alternative allocations by 5 percent annually, as opposed to 1 or 2 percent for traditional investments.

McKinsey, the firm behind the survey, said the prevailing sentiment among respondents was that the bull market won’t last forever. But pension funds’ assumed annual rates of return—which usually sit between 7 and 8 percent—won’t change anytime soon.

It’s for precisely that reason that institutional investors are turning to hedge funds, writes McKinsey & Co:

“With many defined-benefit pension plans assuming, for actuarial and financial reporting purposes, rates of return in the range of 7 to 8% — well above actual return expectations for a typical portfolio of traditional equity and fixed-income assets — plan sponsors are being forced to place their faith in higher-yielding alternatives.”

That doesn’t necessarily translate to investing with hedge funds. But often, it does.

And it’s not just about chasing high returns, the report said:

“Gone are the days when the primary attraction of hedge funds was the prospect of high-octane performance, often achieved through concentrated, high-stakes investments. Shaken by the global financial crisis and the extended period of market volatility and macroeconomic uncertainty that followed, investors are now seeking consistent, risk-adjusted returns that are uncorrelated to the market.”

Only time, and piles of financial reports, will reveal which direction the trend ultimately goes.

Survey: Pensions Funds Will Continue To Increase Alternative Investments

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Often, media narratives don’t properly reflect the reality of a situation.

For example, news has been breaking over the past few weeks of pension funds decreasing their exposure to hedge funds and alternatives. That includes CalPERS, who plan to chop their hedge fund investments dramatically. The reason: high fees associated with those investments are eating into returns.

But according to a new report, pension funds are planning to increase their allocations toward alternatives, more than any other asset class, for years to come.

Consulting firm McKinsey & Co. surveyed 300 institutional investors about their future plans investing in alternatives. (McKinsey defines “alternatives” as hedge funds, funds of funds, private-equity funds, real estate, commodities and infrastructure investments.)

As for the question of whether funds will continue to invest in alternatives, the answer was a resounding yes: the respondents indicated they would like to increase their exposure to alternatives by 5 percent annually.

The reportnotes that pension funds believe their traditional investments, which have been garnering great returns as the bull market saunters on, run the risk of not meeting actuarial return assumptions in the medium-term, or when the market comes down off its high. At that point, pension funds want to be invested in higher-yielding instruments to meet return assumptions. From CFO Magazine:

McKinsey suggests that the bull market, now more than five years old, can’t be expected to continue indefinitely. Indeed, the report says institutional investors that manage money for pension plans are moving more money into alternatives out of “desperation.”

“With many defined-benefit pension plans assuming, for actuarial and financial reporting purposes, rates of return in the range of 7 to 8% — well above actual return expectations for a typical portfolio of traditional equity and fixed-income assets — plan sponsors are being forced to place their faith in higher-yielding alternatives,” McKinsey writes.

But, the consulting firm notes, the rapid growth of alternatives is not simply the result of investors chasing high returns. “Gone are the days when the primary attraction of hedge funds was the prospect of high-octane performance, often achieved through concentrated, high-stakes investments. Shaken by the global financial crisis and the extended period of market volatility and macroeconomic uncertainty that followed, investors are now seeking consistent, risk-adjusted returns that are uncorrelated to the market.”

The Los Angeles Fire and Police Pensions fund is at least one fund going against the grain here: it recently took 100 percent of its money out of hedge fund investments.

Six Years Later, Warren Buffett Is Winning His Bet Against Hedge Funds

In 2008, Warren Buffett made a $1 million wager with alternatives firm Protégé Partners. The money came from Buffet’s own pocket, not Berkshire’s. Around the country, the ears of pension funds began perking up in anticipation. The bet:

“Over a ten-year period commencing on January 1, 2008, and ending on December 31, 2017, the S&P 500 will outperform a portfolio of funds of hedge funds, when performance is measured on a basis net of fees, costs and expenses.”

In other words, Buffett bet that, taking into account investment expenses, an index fund would outperform a fund of hedge funds over a ten-year period. The thinking is in line with what Buffet has publicly said in the past. And, six years later, Buffett is winning his bet.

(The winner of the bet, by the way, will donate the money to a charity of his choice).

This bet is of particular interest to pension funds because alternative asset classes have increasingly become part of their investment portfolios. Regardless of who wins the bet, however, the results will be largely symbolic.

But the over-arching philosophies behind the wager are still interesting to examine. For Buffett, his dislike of hedge funds comes down to fees.

Costs skyrocket when large annual fees, large performance fees, and active trading costs are all added to the active investor’s equation. Funds of hedge funds accentuate this cost problem because their fees are superimposed on the large fees charged by the hedge funds in which the funds of funds are invested.

A number of smart people are involved in running hedge funds. But to a great extent their efforts are self-neutralizing, and their IQ will not overcome the costs they impose on investors. Investors, on average and over time, will do better with a low-cost index fund than with a group of funds of funds.

On the other end, Protégé Partners defends hedge funds:

Mr. Buffett is correct in his assertion that, on average, active management in a narrowly defined universe like the S&P 500 is destined to underperform market indexes. That is a well-established fact in the context of traditional long-only investment management. But applying the same argument to hedge funds is a bit of an apples-to-oranges comparison.

Having the flexibility to invest both long and short, hedge funds do not set out to beat the market. Rather, they seek to generate positive returns over time regardless of the market environment. They think very differently than do traditional “relative-return” investors, whose primary goal is to beat the market, even when that only means losing less than the market when it falls. For hedge funds, success can mean outperforming the market in lean times, while underperforming in the best of times. Through a cycle, nevertheless, top hedge fund managers have surpassed market returns net of all fees, while assuming less risk as well. We believe such results will continue.

Pension360 has covered the emerging trend of pension funds, including CalPERS, reducing their investments in hedge funds.

Photo by Fortune Live Media via Flickr CC

Taking Stock of Where Rhode Island’s Candidates for Governor Stand On the Release of Pension Hedge Fund Records

Last month, current Rhode Island Treasurer Gina Raimondo (Democrat) denied the Providence Journal access to records relating to the state pension fund’s hedge fund investments.

The newspaper appealed, but that appeal was denied as well.

In a letter written by Raimondo at the time of the denial, she justified her actions with the following logic (the entire letter can be read at the bottom of this post):

For democracy to work, the public, often through the press, needs oversight over how government is acting on its behalf. At the same time, the government, to fulfill its obligations to the public, needs to be able to function effectively, which often requires a measure of confidentiality, particularly when contracting with private sector entities. Over the years, the law has determined how to balance these two requirements, and the actions of Treasury were consistent with that balance.

With elections only a few months away, and Raimondo in the midst of a bid for governorship of the state, Raimondo’s opponents have seized the opportunity to pounce on her decision to deny access to the hedge fund records.

Providence Mayor Angel Taveras (Democrat), who is now running for governor of the state, had this to say:

“Apparently, the treasurer is more concerned about hedge funds being able to keep their talent than taxpayers knowing how their money is being spent,” Taveras’ spokeswoman Dawn Bergantino said. “The treasurer should be looking out for our interests, not Wall Street and hedge fund billionaires.”

Allan Fung (Republican) is currently the mayor of Cranston, Rhode Island. But he’s in the running for governor of the state as well, so he put his thoughts on the table:

“There is a dramatic difference between what is required legally and what is necessary to do the right thing,” Fung said. “Current and retired state employees depend on the strength of the pension fund for their retirement security, and all Rhode Islanders face the risk of higher taxpayer contributions if these investments come up short. We all face tremendous risk and we deserve to know the basis for these investments.”

According to the latest polls, Taveras is currently up on Raimondo, garnering 33.4 percent of the vote to Raimondo’s 29 percent. Clay Pell remains a distant third with 11.5 percent of the vote.

Raimondo’s position has notably diminished since she chose to withhold the hedge fund records. Although she is drawing in the same percentage of votes, the issue may have swayed undecided voters to side with Taveras.

On the Republican side, the latest poll has Ken Block maintaining a healthy lead over rival Allan Fung.

Screen shot 2014-08-05 at 2.49.57 PM — Credit: Wikipedia

And, as promised, here is the letter that Raimondo wrote when she denied the Providence Journal access to the state pension fund’s hedge fund records.

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Photo by: By Jim Jones (Own work) via Wikimedia Commons

Memphis’ Pension Fund Is Considering Going All-In On High-Risk Strategies

For the last two years, the City of Memphis Pension Fund has been considering an overhaul in investment strategy. The strategy: re-allocating hundreds of millions of dollars from U.S. stocks and bonds into higher-risk investments. That entails increased allocations toward private equity, hedge funds, foreign stocks and bonds and real estate investments.

On August 28, the board that makes investment decisions for the fund will vote on the change in policy.

The board had already voted at its last meeting to allow the fund to double its real estate investments, from 5 percent of its portfolio to 10 percent.

Video: The Evolution of Allocating to Hedge Funds

Bloomberg TV sat down with Agecroft Partners founder Don Steinbrugge to talk about pension fund investments in hedge funds and what it means for both sides.

Other topics touched: hedge funds facing the reality of having to settle for less fees and more transparency to play ball with pension funds, and paying pension fund staff market rates. Watch the video here:

Pension360 has also covered the recent counter-evolution of hedge fund allocation, a trend in which many pension funds across the country are pulling back their hedge fund investments.

CalPERS, for instance, plans to pull back 40 percent of their hedge fund investments in the near future.

Photo by Simon Cunningham via Flickr CC License

Consultant rips North Carolina for “over-the-top” pension fund fees

The State Employees Association of North Carolina (SEANC) smelled something fishy going on at the North Carolina Treasurer’s office even before they hired a consultant to investigative the fees paid to the Wall Street money managers who handle the state’s pension funds.

The ensuing investigation found that North Carolina isn’t just paying sky-high fees—the state is hiding them, as well.

According to the hired consultant, North Carolina paid a whopping $416 million in fees to Wall Street last year alone; the fees went primarily to Franklin Street Advisors, the firm that manages much of North Carolina’s pension fund assets.

The consultant hired to investigate, Edward Siedle, provides more details at Forbes:

Indeed, it appears that the massive hidden fees she’s not disclosing dwarf the excessive fees she has. For example, the fee information provided to SEANC indicates that…the pension paid $1.8 million in asset-based fees and $800,000 in incentive fees, or a total of approximately $2.6 million for managing approximately $360 million. This amounts to an apparent 50 basis point asset-based fee and a 5 percent incentive fee. (To date the Treasurer has failed to provide the investment advisory contracts which recite, in part, the fees money managers charge the pension.)

Since Franklin Street is a fund of funds, the underlying hedge fund managers are generally paid a 2 percent asset-based fee and a 20 percent incentive fee. It appears that the Treasurer is not disclosing the significant fees paid to the underlying hedge fund managers actually managing the money—fees which are far greater than Franklin’s fees for simply overseeing them.

It appears that the undisclosed underlying fees related to the Franklin investment alone—just one of the hundreds of funds in which state pension has invested—amount to $7.2 million in asset-based fees and $3.2 million in incentive fees or $10.4 million in 2013.

Since it appears that Franklin has managed this account for approximately 12 years, the undisclosed asset management fees paid to this manager alone appear to exceed $120 million.

However, based upon a review of relevant SEC filings, it appears that there may be additional significant fees, amounting to an estimated $3 million annually, paid to Franklin that are not disclosed.

A spokesman for the state’s Treasurer’s office claimed the consultant, Siedle, drew his conclusions by making assumptions that are “not based on conventional industry standards.”

The spokesman also said the fees paid to its money managers are in line with what other states pay.

A recent study by the Maryland Public Policy Institute examined the relationship between the performance of public pension funds and the investment fees they pay. The study found that, over the last 5 years, the pension funds of the 10 states that paid the least amount of fees all outperformed the funds of the 10 states paying the highest fees.

Photo Credit: Manu-H via Flickr Creative Commons License

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