The Elephant Leaves the Room

Implications of Calpers’ Decision to Exit Hedge Funds



The news was greeted with shock by some, while others wondered what took so long. In perhaps the first of many shoes to drop on the hedge fund industry, the largest U.S. pension fund, Calpers (California Public Retirement System) announced it will sell all of its hedge fund investments within 12 months. Media stories on this announcement were quick to cite lagging performance of these funds over the past year, but it appears Calpers was more concerned with the level of fees and lack of “transparency”…that is, they did not know what the heck was going on inside of many of the funds.


All of this serves to highlight several issues swirling around the alternative investment business, which has attracted attention over the years from both ends of the spectrum: some hedge funds have delivered remarkable performance, yet they are also the root of much evil in the eyes of investors. (Note to self: never call yourself a Master of the Universe, not even in jest!).


• Performance: hedge fund detractors are quick to point out that hedge funds have underperformed traditional stock/bond allocations in recent years. The Wall Street Journal reported that the HFR Composite Index (hedge fund benchmark) has trailed the Vanguard Balanced Index Fund since 2009. Well, given the run higher in stocks and bonds during most of that period, should we be surprised? We are NOT defending hedge funds here. We are simply pointing out that if you choose a historically strong period for traditional investing, don’t expect approaches that aim to behave differently than those traditional styles to compete too well.


• Liquidity and Transparency: it appears that Calpers is more in sync with our personal view than ever. Specifically, you want to understand what you own, and know how quickly it can be converted to cash in an emergency. Hedge funds are not very good at that.


• Income: one of our gripes about the alternative investment space is that the majority of that universe emphasizes growth and preservation, but not retirement income. With so many people retiring each day, straightforward income strategies that also hedge major risk are largely absent. That is why we created the Sungarden Hedged Dividend strategy a few years ago.


• Investment Costs: this was one of the big issues for Calpers. We agree that hedge fund costs are exorbitant in many cases. But we also see a growing and unhealthy obsession with investment costs. Some investors are treating all investment styles alike and merely seek out the lowest cost, regardless of any offsetting factors. This seems to us to be an error in judgment similar to other times in history which preceded market tops.

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