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San Francisco Pension To Consider Smaller Foray Into Hedge Funds

The San Francisco Employees’ Retirement System has spent the better part of 6 months weighing whether to dive into hedge funds for the first time.

The fund was originally considering a plan to invest up to 15 percent of assets – or $3 billion – in hedge funds. But the figure was too high for many board members, and the vote was tabled numerous times.

Now, the board is considering a proposal that would allow the fund to invest up to 3 percent of assets in hedge funds – a much smaller allocation that may be more palatable to board members.

From Bloomberg:

The president of the San Francisco Employees’ Retirement System board has asked advisers to look at a hedge fund investment of zero or 3 percent, less than the 15 percent proposed by the pension’s staff.

The board will meet today in San Francisco to consider the proposals, which are part of a broader effort to recalibrate the fund’s asset allocation. The updated figures were in a letter from Angeles Investment Advisors.

“The VM mixes have higher volatility,” Leslie Kautz and Allen Yeh wrote in a Nov. 25 memo to Victor Makras providing modeling on several mixes that they said he specified.

[…]

The hedge fund proposal stems from a June meeting when the San Francisco staff recommended changes to the fund’s asset allocation and the board voted to take 90 days to study options.

The staff recommended a 15 percent hedge-fund allocation, citing good returns, low volatility and very good risk-adjusted returns, according to a memo today to the board from William Coaker, the fund’s chief investment officer.

“Hedge funds provide good protection when stocks decline,” Coaker said. “Since 1990, they have lost only one-fourth the amount stocks have lost in market downturns.”

The San Francisco Employees’ Retirement System manages $20 billion in assets, none of which are allocated to hedge funds.

Photo by ilirjan rrumbullaku via Flickr CC License

Pension Funds: Hedge Funds Should Meet Benchmarks Before Charging Fees

Pension funds and other investors called for changes Tuesday in the way hedge funds charge fees.

The proposed changes were outlined in a statement by the Alignment of Interests Association (AOI), a hedge fund investor group to which many pension funds belong.

The group said that hedge funds should only charge performance fees when returns beat benchmarks, and that fee structures should better link fees to long-term performance.

More details from Bloomberg:

The Teacher Retirement System of Texas and MetLife Inc. are among investors that yesterday called on managers to beat market benchmarks before charging incentive fees in a range of proposals that address investing terms. Funds should base performance fees on generating “alpha,” or gains above benchmark indexes, and impose minimum return levels known as hurdle rates before they start levying the charges, said the Alignment of Interests Association, a group that represents investors in the $2.8 trillion hedge fund industry.

“Some managers are abiding by the principals to some extent but we are hoping to move everyone toward industry best practices,” said Trent Webster, senior investment officer for strategic investments and private equity at the State Board of Administration in Florida. The pension plan, a member of the association, oversees $180 billion, of which $2.5 billion is invested in hedge funds.

[…]

To better link compensation to longer-term performance, the AOI recommended funds implement repayments known as clawbacks, a system in which incentive money can be returned to clients in the event of losses or performance that lags behind benchmarks. The group said performance fees should be paid no more frequently than once a year, rather than on a monthly or quarterly basis as they are at many firms.

AOI also called on the hedge fund industry to lower management fees – or make operating expenses more transparent so higher management fees can be justified. From Bloomberg:

Management fees, which are based on a fund’s assets, should decline as firms amass more capital, the investor group said.

“We need good managers, not asset gatherers,” Webster said. “The incentives are currently skewed.”

[…]

Firms should disclose their operating expenses to investors so they can assess the appropriateness of management fee levels, the group said.

“Management fees should not function to generate profits but rather should be set at a level to cover reasonable operating expenses of a hedge fund manager’s business and investment process,” the AOI said.

The fees should fall or be eliminated if a manager prevents clients from withdrawing money, according to the group.

Hedge funds typically utilize a “2 & 20” fee structure; but in the second quarter of 2014, hedge funds on average were charging “1.5 & 18”.

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Survey: Pension Funds Looking to Increase Internal Asset Management

Pension funds across the world are looking to bring asset management responsibilities in-house, according to a recent survey by State Street.

In addition, a majority of funds are thinking of turning to lower-cost investment strategies.

From ValueWalk:

Over the next three years, a whopping 81 percent of pension fund respondents said they are exploring bringing more asset management responsibilities in-house. A primary reason? Fees and costs were a major issue, with 29 percent saying it was a challenge for the pensions to justify the fees of their asset managers.

An unspoken issue is the relatively low returns, as many hedge funds are both highly correlated to the performance of the stock market as well as underperforming major stock market indices. This leads to the question: why not just primarily invest in an stock index ETF for the primary equity exposure?

As part of this shift to internal investing, 53 percent of the respondents are expecting to use more lower-cost strategies to achieve desired investment outcomes. This would likely include low cost ETFs designed to capture the beta of the stock market.

“Pension funds’ desire to deliver strong investment returns to their participants coupled with improved oversight and governance and is leading to a need for more in-house accountability for asset and risk management,” said Martin J. Sullivan, head of Asset Owner sector solutions for North America, State Street. “However, this undertaking requires pension funds to carefully evaluate how to achieve a balance of in-house and external talent, tools and technologies.”

The survey polled 134 pension executive from the Americas, Europe, the Middle East, Africa and Asia.

Rhode Island Pension Investment Board Reviews Hedge Fund In Closed-Door Meeting

Rhode Island governor-elect Gina Raimondo and the state Investment Commission held a closed-door meeting last week to review a particular hedge fund, Mason Capital, in which $61.7 million of pension money is currently invested.

The exact reason for the meeting, and what was said during, is unknown because the session was exempt from the state’s Open Meetings Law.

The minutes of the meeting are sealed to “protect the interest of the state’s pension fund”, according to a Raimondo spokesman,

NYC Pension Appoints New Heads of Private Equity, Hedge Fund Investments

The New York City Bureau of Asset Management – the entity that manages assets for the city’s retirement systems—has appointed two staffers to head its private equity and hedge fund investments, respectively.

The backgrounds of the appointees, from Chief Investment Officer:

Effective immediately, NYC’s comptroller appointed Alex Doñé as head of private equity and Neil Messing to take over the hedge fund portfolio.

Doñé has worked at the bureau, investing the city’s five pension funds, since 2012. Prior to the promotion, he served as the fund’s executive director of private equity and oversaw its $5.6 billion emerging managers program.

He spent the bulk of his earlier career in the private sector, with 16 years of experience in investment banking and private equity. Doñé has worked at Clearlake Capital Group, KPMG Corporate Finance, and Merrill Lynch. For two years, he served as a presidential appointee at the US Department of Commerce’s Minority Business Development Agency.

The NYC pensions’ new head of hedge funds likewise built his background in the private sector before becoming an asset owner in 2011. Messing most recently served as the fund’s senior investment officer responsible for hedge funds. According to the NYC comptroller’s office, he “built and managed a diversified $4 billion portfolio of direct hedge fund investments and a fund-of-hedge funds” for the pensions.

The CIO of the city’s pension system commented on the appointments:

“The appointment of Alex and Neil will strengthen the investment operations of the Bureau of Asset Management,” said Scott Evans, CIO of the New York City Pension Funds. “Alex and Neil are ethical and sophisticated investment managers and I am excited to see them take on new roles as part of senior leadership.”

The New York City Bureau of Asset Management manages $160 billion in assets for the city’s pension systems.

Pennsylvania Auditor General Urges State Pensions to Pull Back From Hedge Funds, “Dramatically” Reduce Risk

Pennsylvania Auditor General Eugene DePasquale has been vocal in the past about his desire for the state’s pension systems to decrease their allocations to hedge funds.

He doubled-down and expanded on that stance Thursday, saying the state-level pension funds’ risk appetite needs to be “dramatically pulled back”.

He also called on the pension systems to reduce investment fees and change funding models.

DePasquale made these announcements after examining the pension system of Montgomery County, which uses a low-cost investment approach that includes investing heavily in passive index funds. The approach represents a stark contrast with the state-level pension systems.

Montgomery County Commissioners Josh Shapiro explains how his county’s pension fund operates:

Historically the county invested money from the pension fund with Wall Street money managers, Shapiro explained.

“What we found was that they just were simply not getting the returns our retirees needed,” Shapiro said. “We, as a pension board, worked hard at looking at different models of funding our pension system that would work better than what we historically had.”

Shapiro said the county began investing 90 percent of the fund in Vanguard two years ago and has since has seen a return of 16.23 percent while saving more than over $1 million in fees.

“We knew we were creating a template that could be used by other municipalities and maybe even by the state,” Castor said. “The obligation that we have to our retirees is to make sure the funding is there today, tomorrow and 40 years from now. The health of that plan is part of the covenant we have with the people who do the work here at Montgomery County and at the state.”

DePasquale then suggested that the state-level pension systems could learn from the successes of Montgomery County, according to the Times-Herald:

DePasquale said the state needs to emulate Montgomery County, where the pension funds are invested in a stock index fund.

“Before you get there we have to reduce our exposure into the hedge fund area,” he said.

According to DePasquale, the public school retirement system has 10 percent of its investments in hedge funds, while the state employee retirement system has approximately 6 percent of investments in hedge funds.

“That risk needs to be dramatically pulled back,” DePasquale said.

A final point DePasquale made about the state pension system is that the fees going to private equity and hedge fund managers need to be reduced.

“Pennsylvania is a large state,” he said. “We have a huge leverage tool in the amount of money that we have in our pension system. For some reason our Public School Employment Retirement System and our State Employment Retirement System refuses to use that leverage to negotiate lower fees.”

This isn’t the first time DePasquale has asked the state’s pension funds to pull back from hedge funds.

That led pension officials to defend their hedge fund investments. The chairman of the Pennsylvania’s State Employees Retirement System board of trustees said this in September:

Industry experts generally agree that while hedge funds are not for every pension system, the unique needs of each system must shape their individual asset allocation and strategic investment plans. Therefore, the actions taken by one system may not be appropriate for all systems. Investors need to consider many factors including their assets, liabilities, funding history, cash flow needs, and risk profile.

[…]

To date, the strategy has been working. As of June 30, 2014, our diversifying assets portfolio, or hedge funds, made up approximately 6.2 percent of the total $28 billion fund, or approximately $1.7 billion. In 2013, that portfolio earned 11.2 percent or $197 million, after deducting fees of $14.8 million, while dampening the volatility of the fund. That performance helped the total fund earn 13.6 percent net of fees in 2013, adding more than $1.6 billion to the fund.

Photo by Paul Weaver via Flickr CC License

Paul Singer: CalPERS’ Hedge Fund Exit Was “Off-Base”

Paul Singer, a hedge fund manager, activist investor and billionaire, wrote in a recent letter to clients that CalPERS’ exit from hedge funds was “off-base”.

CalPERS said at the time that its decision to exit hedge funds was based on their “complexity, cost and the lack of ability to scale at CalPERS’ size”.

Singer responded to those criticisms, according to CNBC:

“We are certainly not in a position to be opining on the ‘asset class’ of hedge funds, or on any of the specific funds that were held or rejected by CalPERS, but we think the decision to abandon hedge funds altogether is off-base,” Singer wrote in a recent letter to clients of his $25.4 billion Elliott Management Corp.

[…]

On complexity, Singer wrote that it should be a positive.

“It is precisely complexity that provides the opportunity for certain managers to generate different patterns of returns than those available from securities, markets and styles that are accessible to anyone and everyone,” the letter said.

Singer also took issue with claims that drawbacks of hedge funds include opaqueness and high fees. From CNBC:

“We also never understood the discussions framed around full transparency. While nobody wants to invest in a black box, Elliott (and other funds) trade positions that could be harmed by public knowledge of their size, short-term direction or even their identity.”

Singer also slammed CalPERs for its complaint about the relative high cost of hedge funds.

“We at Elliott do not understand manager selection criteria based on the level of fees rather than on the result that investors could reasonably expect after fees and expenses are taken into account,” he wrote.

The broader point Singer makes is on the enduring value of hedge funds to diversify a portfolio.

“Current bond prices seem to create a modest performance comparator for some well-managed hedge funds. Moreover, stocks are priced to be consistent with bond prices, and we have a hard time envisioning double-digit annual stock index gains in the next few years,” the letter said.

“Many hedge funds may have as much trouble in the next few years as institutional investors, but investors should be looking for the prospective survivors of the next rounds of real market turmoil.”

Hedge funds have returned 2.92 percent this year, according to Preqin. Singer’s hedge fund, Elliott Associates LP, has 13.9 percent annually since 1977.

Photo by World Economic Forum via Wikimedia Commons

Kolivakis Weighs In On South Carolina Pension’s Search For Smaller Hedge Fund Managers

Last week, South Carolina treasurer Curtis Loftis said the state’s pension system was looking to work with smaller hedge fund managers.

Loftis told emerging hedge fund managers to “come show up” at pension meetings and to “shake hands…pass out cards.”

Data exists that supports investing with smaller, newer hedge funds.

Leo Kolivakis, who runs the blog Pension Pulse, weighed in on Loftis’ decision:

I’m glad Curt didn’t hand over his seat and think he’s on the right track bringing light to the excessive fees South Carolina’s pension fund is doling out. The guy who said there is no uniform reporting guidelines in fees is partially right but there should be, especially in alternatives like private equity where many state funds are getting bullied into remaining mum on fees and terms.

As far as focusing on emerging managers, there too, I think he’s on the right track. Smaller hedge funds have withered but the irony is they typically outdo their elite rivals. Why? Because their focus is primarily on performance, not asset gathering (2% management fee really kicks in when managing billions, just ask Ray Dalio, Bill Ackman and other oversized hedge fund egos that now figure among the richest Americans).

Are there pitfalls to investing in smaller funds? You bet there are and I warn Curt and others taking this approach not be be penny-wise and pound-foolish. There are a bunch of charlatans in Hedgeland that know how to talk up their game but they’re pure cons. And many smaller hedge funds stink, just like most of their larger rivals. There is also the big issue of scalability, which most smaller players don’t offer or are not set up for.

I’m not a fan of funds of funds but when it comes to identifying and selecting emerging managers, you need to be cautious and find true alpha generators that will offer you a lot more than just performance (knowledge leverage is critical!). Talking to Tom Hill at Blackstone or Jane Buchan at Paamco is a very good idea but make sure you get the terms and fees right when dealing with funds of funds.

South Carolina’s pension system allocated 17 percent of its assets towards hedge funds as of June 30.

South Carolina Pension Seeks Smaller Hedge Fund Managers

The South Carolina Public Employee Benefit Authority (PEBA) allocates a large portion of its assets towards hedge funds – 17 percent, as of June 30.

But PEBA is looking for a change. It isn’t considering moving away from hedge funds, but it is looking at different kinds of hedge funds. Namely: smaller ones.

From Bloomberg Briefs:

South Carolina’s pension is interested in allocating to smaller hedge fund managers to enhance diversification and capture increased returns as it reduces holdings in larger funds, according to state treasurer Curtis Loftis.

The $30 billion pension had 14 investments in “strategic partnership funds” of $1 billion or more at the start of this year, of which it has “unwound about half,” Loftis said in a speech at the Alternative Asset Summit in Las Vegas last month. It is “very interested in emerging managers” to help with this “fear of non-diversification, and to enhance returns” he said in the Oct. 28 speech. The pension has already made “several or so investments of $50 million or less the last few of months,” he said. This includes a commitment of $25 million to $50 million last month to a small manager that Loftis declined to identify.

“I love alternative investments. I love Wall Street. I don’t mind paying fees,” Loftis said in 2013. “But I want returns.” The pension last year had investment fees and expenses of 1.59 percent of assets, compared to a national average of 0.57 percent, according to a presentation on its website.

[…]

The state treasurer suggested emerging hedge funds to “come show up” at public meetings of public pension plans, including the South Carolina Investment Commission. “If I were an emerging manager and I wanted to understand how public pension plans work, I would attend the meetings, shake hands and pass out cards.”

The move is interesting because there is data out there suggesting pension funds can get the best returns by investing with newer, smaller hedge funds.

Dr. Linus Wilson writes:

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.

Dr. Wilson believes pension funds are ignoring data that suggests newer, smaller managers perform better than the older, larger hedge funds that pension funds typically prefer

Read Dr. Wilson’s entire piece here.

Video: New York City Comptroller Talks About Push By Pension Funds For More Control of Corporate Boardrooms and City’s Hedge Fund Allocation

Here’s an interview with New York City Comptroller Scott Stringer. Stringer is trustee of the City’s five pension funds.

During the course of the interview, Stringer talks about his push for pension funds to have more control over corporate boardrooms. He also defends the city pension system’s hedge fund allocations.

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