The big news in the alternatives world this week is of course that the largest pension in the world CalPERS is ditching it’s Absolute Return unit and unloading $4 Billion worth of hedge funds. Is this the end of hedge fund investing by institutional investors (an earthquake), typical performance chasing by an investor (albeit a very large one), or a result of their enormous size (Godzilla).
If you believe Barry Ritholtz over at Bloomberg – this is an “earthquake” for hedge funds, with other pensions following suit and advisors and the rest eventually waking up to the realization that hedge funds don’t provide higher returns than equities.
This is a huge change… It has enormous potential for disrupting the consultants and infrastructure of the 2 & 20 firmament.
If you believe some hedge fund managers who were quoted in a Business Insider piece – this isn’t about the hedge fund industry’s ability to meet investor expectations, it’s about CalPERS inability to pick managers who could meet their expectations. We even get a little insight into how their manager selection may have suffered:
They got what they paid for since they only invested in managers who would cut fees. So the best funds wouldn’t do that, so they had a mediocre portfolio.
So is this proof that hedge funds don’t deliver on their promise (note to Mr. Ritholtz, most hedge fund’s “promise” isn’t to get “higher” returns than equities… it’s about non correlated returns and better risk adjusted returns), or is it about CalPERS being a poor investor?
We agree with Ritholtz that there are a lot of under performing hedge funds out there and a lot of them are expensive. But institutional investors don’t seem to be as upset about fees and correlation and all the rest of it. A recent survey showed 95% of institutional investors planned on maintaining or increasing their hedge fund allocations (58% maintaining, 36% increasing).
That’s not to say we don’t agree that the grand majority of hedge funds are way more correlated to equities than people investing in ‘alternatives’ would be led to believe. But we also don’t think a group like CalPERS was duped by this. They knew full well the correlation to equities they were getting involved with. Indeed, they likely viewed the absolute return portfolio as more and more a way to capture equity-like beta with lower risk, like many institutional investors do. The problem CalPERS faced that doesn’t pop up for other pensions and investors, is their gargantuan size.
CalPERS $4 Billion in hedge funds was just 1.3% of their portfolio, meaning they have a staggering $298 Billion in assets their controlling for future California state employee retirees. Trying to invest that much money is like turning the proverbial battleship. They just can’t be all that nimble. And indeed, that was one of the reasons given by CalPERS for their hedge fund exit: “the lack of ability to scale at CalPERS’ size”
So say CalPERS actually loved the hedge fund model, and saw that they could get equity like returns (after fees!) with less risk over a full market cycle. Now what? They have $160 Billion of stock market exposure! Porting that over to the hedge fund world simply wouldn’t work. They would immediately become over 10% of the entire hedge fund industry ). They would max out the capacity of nearly every manager they worked with. They would become a huge tail wagging the dog.
More than anything, what we’re may really be seeing here is the upper bound of the hedge fund/institutional investor asset allocation game. It’s the curse of being the Godzilla of institutional money. CalPERS seemed like the best client a hedge fund could have… with nearly $300 billion in assets which could be allocated to hedge funds, but some boring performance on what really amounted to a test run (1.5% of assets), likely made them see that even if they were good at picking the right hedge funds – they couldn’t play in that pool in any real meaningful way.
PS – maybe Calpers should move fully into the discount fee camp and just use a Robo-Advisor (link)