hedge funds | Pension360

What Does CalPERS’ Hedge Fund Pullout Mean For the “Average” Investor?

Larry Zimpleman, chairman and president of Principal Financial Group, has written a short piece in the Wall Street Journal today detailing his reaction to CalPERS cutting hedge funds out of their portfolio and what the move means for the average investor.

From the WSJ:

I was very interested (and a bit surprised) to read about the decision of Calpers (the California Public Retirement System) to move completely out of hedge funds for their $300 billion portfolio.

While I haven’t visited directly with anyone at Calpers about the reasons for their decision, from the stories I’ve read, it seems to be a combination of two things. First, it’s not clear that hedge-fund returns overall are any better than a well-diversified portfolio (although the management fees of hedge funds are much higher). Second, hedge funds had only about a 1% allocation in the overall portfolio. So even if they did provide a superior return, it would have a negligible impact on overall performance.

What’s the takeaway for the average investor? First, if you have “alternatives” (like hedge funds) in your own portfolio, they need to be a meaningful percentage of your portfolio (something like a 5% minimum). Second, take a hard look at the recent performance against the management fees and think about that net return as compared to a well-diversified stock and bond portfolio. Hedge funds are, as their name implies, set up more for absolute performance and outperformance during stressed times. If you’re a long-term investor that believes in diversification and can tolerate volatility, hedge funds may be expensive relative to the value they provide, given your long-term outlook.

Principal Financial Group is one of the largest investment firms in the world and also sells retirement products.

Zimpleman’s post was part of the WSJ’s “The Expert” series, where industry leaders give their thoughts on a topic on their choice.

San Francisco Pension Backs Off Hedge Funds After Conflicts of Interest Surface

San Francisco Employees’ Retirement System (SFERS) was set to vote yesterday on whether the fund should allocate up to 15 percent of assets, or $3 billion, to hedge funds.

But the vote never happened, in part because of the objections of union members and retirees who showed up to the meeting. Recent reports of conflicts of interest surrounding the hedge fund investments probably didn’t help, either.

From the International Business Times:

San Francisco officials on Wednesday tabled a proposal to move up to 15 percent of the city’s $20 billion pension portfolio into hedge funds. The move came a day after International Business Times reported that the consultants advising the city on whether to invest in hedge funds currently operate a hedge fund based in the Cayman Islands.

The hedge fund proposal, spearheaded by the chief investment officer of the San Francisco Employees’ Retirement System, or SFERS, had been scheduled for action this week. If ultimately enacted, it could move up to $3 billion of retiree money from traditional stocks and bonds into hedge funds, potentially costing taxpayers $100 million a year in additional fees.

Pension beneficiaries who oppose the proposal spoke at Wednesday’s meeting of the SFERS board. They cited financial risks and the appearance of possible conflicts of interest in objecting to the hedge fund investments.

Prior to the meeting, the Service Employees International Union, which represents roughly 12,000 members who are eligible for SFERS benefits, asked city officials to have the hedge fund proposal evaluated by a consultant who has worked with boards that have opted against hedge funds.

David Sirota reported on the possible conflicts of interest earlier this week:

[SFERS is] drawing on the counsel of a company called Angeles Investment Advisors, one of a crop of consulting firms that has emerged across the country in recent years to aid municipalities in navigating the murky waters of managing money.

For two decades, Angeles has been employed by the San Francisco pension system to champion the best interests of city taxpayers and employees — the cops, firefighters and other municipal workers who depend on pension payments after their retirement. But the firm is concurrently playing another role that complicates its image as a disinterested guide: An International Business Times review of U.S. Securities and Exchange Commission documents has found that since 2010, Angeles has run a hedge fund based in the Cayman Islands that invests in other hedge funds.

In other words, the consultants that are supposed to be providing unbiased advice about whether San Francisco would be wise to entrust its money to the hedge fund industry are themselves hedge fund players.

SFERS says that, although the vote is tabled for now, it could be brought back at a later time.

This isn’t the first time the pension fund has delayed voting on hedge fund investments. In fact, it’s the third time: the board first delayed the vote in June. Then it delayed the vote again in August.

Dan Primack: All Alternatives Are Not Created Equal

Pension funds have been receiving flak from all sides lately regarding alternative investments.

The criticisms have been varied: the high fees, opacity, underperformance and illiquidity.

But, outside of official statements from pension staff defending their investments, it’s not often we get to here from the people on the other side of the argument.

Dan Primack argues in a column this week that not all alternatives are created equal—and the fight against the asset class has been “oversimplified”.

From Fortune:

Hedge funds are considered to be “alternative investments.” So is private equity. And venture capital. And sometimes so is real estate, timber and certain types of commodities.

A number of public pension systems have increased their exposure to “alternatives” in recent years, at the same time that they either have curtailed (or threatened to curtail) payouts to pensioners. The official line is that the former is to prevent more of the latter, but many critics believe Wall Street is getting rich at the expense of modest retirees.

The complaint, however, generally boils down to this: Alternatives have underperformed the S&P 500 in recent years, even though many alternative funds charge higher fees than would a public equities index fund manager. In other words, state pensions are overpaying for underperformance.

Great bumper sticker. Lousy understanding of investment strategies.

The simple reality is that not all alternatives are created equal. Some, like private equity, are more tightly correlated to public equities than are others. Some are designed to chase public equities in bull markets without collapsing alongside them (that’s where the name “hedge” name from). Real estate is largely its own animal. Same goes for certain oil and gas partnerships.

Lumping all of them together because of fee strategies makes as much sense as arguing that a quarterback should be paid the same as an offensive lineman. After all, they both play football, right?

Primack uses New Jersey as an example:

For those who want to criticize public pensions for investing in alternatives, be specific. New Jersey, for example, reported alternative investment performance of 14.21% for the year ending June 30, 2014. That trailed the S&P 500 for the same period, which came in at 21.38% (or the S&P 1500, which came in at 16.99%). But that alternatives number is a composite of private equity (23.7%), hedge funds (10.2%), real estate (12.74%) and real assets/commodities (6.12%). The sub-asset class most tightly correlated to public equities actually outperformed the S&P 500 (net of fees).

Would New Jersey pensioners have been better off without private equity? Clearly not for that time period. Having avoided real estate or hedge funds, however, would be a different argument. But even that case is tough to prove until New Jersey’s relatively immature alternatives program experiences a bear market. For example, both hedge funds and the S&P 500 went red last month, but the S&P 500’s loss was actually a bit worse. And macro hedge fund managers actually had positive returns. Does that make up for years of the S&P 500 outperforming hedge? Likewise, should real estate performance receive an indirect bump from recent rises in venture capital performance, just because they are both “alternatives?”

Again, that’s a judgment call that should be based on voluminous data, rather than on knee-jerk anger that alternative money managers are getting paid while retiree benefits are getting cut. If alternative managers are helping to stem the severity of those cuts, then everyone wins. If not, then the state pension needs a change in policy. But, in either case, the specific alternative sub-asset classes should be analyzed on their own merits, rather than as one homogeneous bucket. Otherwise, critics may throw out the baby with the bathwater.

Read the entire column here.

Photo by 401kcalculator.org

San Francisco Pension Fund Votes Today On Whether To Invest in Hedge Funds

San Francisco Employees’ Retirement System (SFERS) will vote later today on whether to invest in hedge funds for the first time.

If the board votes “yes”, the fund will have the ability to allocate up to 15 percent of its assets toward hedge funds. Reported by Bloomberg:

The hedge fund proposal stems from a June meeting when staff recommended changes to the fund’s asset allocation and the board voted to take 90 days to study options. At a meeting last month, staff suggested shifting the allocation to invest 35 percent in global equity, 18 percent in private equity, 17 percent in real assets, 15 percent in fixed income and 15 percent in hedge funds, according to the [fund CIO] Coaker memo.

The retirement system administers a pension plan and a deferred-compensation plan for active and retired employees. Retirement members include those who had worked for the City and County of San Francisco, the San Francisco Unified School District, the San Francisco Community College District and the San Francisco Trial Courts.

Herb Meiberger, a commissioner and retirement board member, last month called for keeping hedge funds out of the mix. Hedge funds are complex, difficult to understand and carry high management fees, he said in a September memo.

“SFERS is a public fund subject to public scrutiny,” Meiberger wrote in the memo. It’s “one of the best-funded plans in the United States. Why change course?”

[…]

The San Francisco fund had $17 billion in assets based on market value and an unfunded liability of 15.9 percent as of July 1, 2013, a decline from 21.1 percent a year earlier, according to its most recent actuarial valuation report.

The chief investment officer of SFERS, William Coaker, recommended approving hedge funds in a memo this month.

“They have provided good protection in market downturns,” he wrote.

Pennsylvania Pension Chairman Defends Hedge Funds; Says “Strategy Is Working”

Pennsylvania’s top auditor has publicly wondered whether Pennsylvania’s State Employees Retirement System (SERS) should be investing in hedge funds.

SERS has released formal statements defending their investment strategy, which currently allocates 6.2 percent of assets toward hedge funds.

But today, we got the pension fund’s most in-depth defense yet of the asset class.

Glenn E. Becker, chairman of the SERS Board, wrote a letter to the editor of the Patriot News which was published today in the paper. The letter, in full, reads:

I feel it is important to correct the record and explain how our hedge fund exposure has been working for the state’s taxpayers.

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.

Our current plan was designed to structure a well-diversified portfolio to meet the needs of a system that is currently underfunded, steadily maturing (has more retirees than active members) and, in the near term, will receive employer contributions below the actuarially required rate.

Those unique characteristics mean we need liquidity, low cash flow volatility, and capital protection. We must plan to pay approximately $250 million in benefits every month for the next 80-plus years. We continuously monitor fund performance, the markets and cash flows for any needed plan adjustments. At this time, our plan uses hedge funds as an integral component of a well-diversified portfolio that is expected to provide risk-adjusted returns over all types of markets.

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.

Certainly, caution is warranted when examining one short period given SERS’ long-term liabilities. Over the long term, as of December 31, 2013, the total fund returned an annualized, net of fees return of 7.4 percent over 10 years, 8.4 percent over 20 years and 9.7 percent over 30 years.

Over the past 10 years, more than 75 percent of the funds’ assets have come from investments. In terms of making up for the past underfunding, that is money that doesn’t have to come from the taxpayers.

Some Pension Funds Are Interested In The Hedge Funds CalPERS Dropped

The CalPers Building in West Sacramento California. — The CalPERS Building in West Sacramento California.

CalPERS announced plans to phase out its $4 billion hedge fund portfolio last month. But other pension funds are now interested in the hedge funds CalPERS is getting rid of, according to a report from FinAlternatives:

The California Public Employees’ Retirement System already has potential buyers kicking the tires of its $4 billion hedge fund portfolio.

The pension, which last month announced it would take at least a year to “strategically exit” its hedge fund investments, has received indications of interest for some or all of its holdings from other state pension funds, reports Fortune, citing sources familiar with the situation.

The State of Wisconsin Investment Board, which has yet to meet its hedge fund investment targets, was identified by a source as one of those potential buyers.

A CalPERS spokesman told Fortune the pension will “evaluate all possibilities” with the portfolio, but would not confirm interest from other pension funds.

“Ultimately, we will exit those investments in a manner that best serves the interests of the fund,” said the spokesman.

Pension360 has covered the fact that, while CalPERS has exited hedge funds, not many pensions have followed in their footsteps.

Photo by Stephen Curtin via Flickr CC License

Roger Martin: CalPERS, Other Top Funds Could Undermine Capitalism

Roger Martin, Academic Director of the Martin Prosperity Institute at the Rotman School of Management and the world’s 3^rd most influential business thinker according to the Thinkers50 list, has written a thought-provoking column over at the Harvard Business Review.

The premise of the column is that the largest pension funds are monopolistic entities – and although Martin doesn’t think they’re doing a bad job, he is worried that, like most monopolies in history, they will “slowly but surely gravitate to serving themselves, not their customers.”

Here’s a few excerpts from the column:

The top 350 pension and sovereign wealth funds control just under $20 trillion of assets. They are the largest holders of securities in for-profit organizations competing in democratic capitalist environments.

[…]

If one looks carefully at these holders of competitive, capitalist company securities, one thing jumps out distinctly: they are not themselves competitive, capitalist organizations. Virtually all of them share a single form: a monopoly enforced by government regulation. As a Canadian, I have no choice as to where the pension contributions that are legally deducted from my paycheck go. Whether I like it or not they are sent to the Canadian Pension Plan Investment Board. CPPIB is granted a monopoly right by the Government of Canada to serve me (except in Quebec, where the relevant and equivalent monopoly body is the Caisse de Dépôt et Placement du Québec).

The same rules hold in the home of the brave and the land of the free. California state employees, Texas teachers, and New York City workers have zero choice. They are served by government-regulated pension fund monopolies. In fact, 19 of the top 25 U.S. pension funds, with $2.1 trillion of assets under management, are government-regulated monopolies. The other six, with $500 billion of assets, are corporate-run monopolies in which employees have little or no ability to opt out.

Capitalism has broad support because of a general belief in the power of competition, free entry to industries, and customer choice to produce increasing productivity and high levels of innovation. However, the ownership of those actively competing companies is increasingly in the hands of organizations that face zero competition, no threat of entry, and have customers who are forced to use them.

Why is putting the economy in the hands of regulated monopolists a good idea? Obviously, many of those monopolists are doing a good job. I don’t begrudge sending my pension deductions to CPPIB because it is well run and does a nice job for me with my pension savings, and I have to applaud California Public Employees’ Pension Fund (America’s second largest pension fund with about a quarter of a trillion dollars of assets under management) for making the bold and brilliant decision to eliminate hedge fund investments from its holdings.

But the broad history of regulated monopolies is not inspiring. Without the forcing mechanisms of competition, entry, and choice, monopolies slowly but surely gravitate to serving themselves, not their customers.

[…]

If we really believe in competition and choice, then a big question we should all be asking ourselves today is what should be done about our monopolistic pension system?

You can read the rest of the piece here.

Photo by Dave Rutt via Flickr CC License

Report: New York Common Fund Picks Above Average Hedge Fund Managers

Some observers have openly questioned the manager selection habits of pension funds. But a recent analysis shows that at least one fund, the New York Common Retirement Fund, picks “above average” hedge fund managers. From Pensions & Investments:

An analysis of public holdings shows that equity hedge fund managers in the New York State Common Retirement Fund‘s absolute-return strategy exhibit “above average” skill as stock pickers, but are outside the top 25th percentile of the fund universe as a whole.

Symmetric Information Technologies analyzes 13F filings of hedge funds and calculates security selection skill based on funds’ long positions, and their relative performance to overall sector returns. The most recent analysis notes the “accomplishment is still impressive given the restrictions pension funds operate under and shows they are able to pick managers that produced for them better than average skill compared to what is available in the HF universe. This is no easy task.”

Symmetric says three New York State Common Retirement Fund managers – HighFields Capital, ValueAct Capital and Viking Global Advisors – ranked in the top 25th percentile in terms of stock selection.

The Common Fund makes investments for the New York State and Local Retirement System (NYSLRS) as well as other major systems.

The Common fund allocated 3.2% of its assets or $5.6 billion, toward hedge funds.

CalPERS May Be Done With Hedge Funds, But It’s Far From Finished With Fees

There’s been a torrent of media coverage about how CalPERS, with its decision to kick hedge funds to the curb, has also distanced itself from high-fee investment managers.

But nearly $500 million of private equity fees say otherwise, writes the New York Times’ Josh Barro:

Here’s the thing: Calpers, America’s largest public employee pension system, with $300 billion in assets under management, isn’t getting away from investment gurus altogether.

The system’s $4 billion hedge fund program is small potatoes; its main exposure to high-fee gurus is through $31 billion in private equity funds, which just like hedge funds rely on the premise that highly paid fund managers can beat the market through special insight and talent.

Calpers paid $476 million in management fees on its private equity portfolio in the fiscal year ending June 2013, equal to 1.4 percent of private equity assets, about 20 times what it would have cost Calpers to invest a similar amount in stocks and bonds. And Calpers’s commitment to private equity remains strong, guru-driven fees and all.

Ted Eliopoulos, the interim chief investment officer at Calpers, the California Public Employees’ Retirement System, made clear in a statement that the choice to exit hedge funds was specific to the asset class. He criticized hedge funds’ “complexity, cost and the lack of ability to scale at Calpers’s size.” The key word there is “scale”: Even at $4 billion, hedge funds made up just over 1 percent of the Calpers portfolio. That wasn’t enough to make a meaningful difference to the fund’s returns or diversification, and the system didn’t see good opportunities to scale up.

As of 2013, CalPERS invested 10.4 percent of its portfolio in private equity. That’s a big jump from its 6 percent PE allocation in 2006.

But, according to Josh Barro, CalPERS cut its target private equity allocation twice this year—the target allocation at the beginning of 2014 was 14 percent. Now, two downward revisions later, PE’s target allocation sits at 10 percent.

Photo by 401kcalculator.org

Video: Hedge Fund Manager On “Tweaking” Fee Structure

The video above features John Paulson, founder of $22 billion hedge-fund firm Paulson & Co., talking about the fee structure of hedge funds and whether he feels “pressure” to change that structure to appease fee-averse investors.

“Institutions are becoming a little more demanding…they are putting pressure on the management fee and the incentive fee,” Paulson says during the video.

The footage was taken during a panel discussion at New York University’s Stern School of Business.

Video courtesy of the Wall Street Journal.

Deprecated: Function get_magic_quotes_gpc() is deprecated in /home/mhuddelson/public_html/pension360.org/wp-includes/formatting.php on line 3712