Public Pension Funds' Hedge Fund Investment Likely to Continue, Despite CalPERS' Decision

Despite CalPERS decision to exit its hedge fund investments, the trend of public pension allocating more to hedge funds will likely continue, says Preqin.

Earlir this week, CalPERS, the largest public pension fund in the U.S., with approximately $300 billion in assets, decided to exit 24 hedge funds and six hedge fund-of-funds valued at approximately $4 billion.

“We are always examining the portfolio to ensure that we are efficiently and cost-effectively achieving our risk-adjusted return goals,” said Ted Eliopoulos, CalPERS interim chief investment officer. “Hedge funds are certainly a viable strategy for some, but at the end of the day, when judged against their complexity, cost, and the lack of ability to scale at CalPERS’ size, the ARS program is no longer warranted.”

New Jersey’s state pension fund has also come under scrutiny recently for engaging in alleged pay-to-play with hedge funds, as reported by Global Custodian’s sister publication, Chief Investment Officer.

Still, Preqin says that these recent events are not likely to be a reversal of the institutionalization of hedge funds, which has grown to the point where 44% of hedge funds have investments from public pension funds, and 22% of institutional capital invested in hedge funds is from public pension funds, according to Preqin.

“With CalPERS joining the ranks of a handful of other high profile US pension schemes cutting back on hedge funds, there could be concerns that these public retirement systems are losing faith in the asset class as a collective,” says Amy Bensted, head of hedge fund products at Preqin. “For now at least, this does not seem to be the case, and in fact, there are more U.S. public pension funds than ever before allocating capital to hedge funds, and these investors are investing the most they ever have in the asset class. Public pension funds have increasingly recognized the value of hedge funds as part of a diversified portfolio, and although CalPERS’ withdrawal from the asset class will spark some investors to look more closely at their current allocation model, the importance of hedge funds as a source of risk-adjusted returns for these investors is likely to continue to prove attractive for U.S. retirement schemes.”

Preqin’s data shows that from 2010 to year-to-date 2014, the number of active U.S.-based public pension funds invested in hedge funds grew from 234 to 269, with the percentage of AuM invested in the asset class growing 7.2% to 8.6%. And in the first half of 2014, 34% of hedge funds managers reported an increase in capital coming from public pension funds, though hedge funds have had not had the best performance this year.

“With much of the recent criticism on hedge funds focusing on the apparent underperformance of the asset class compared to the equity markets, it is important to recognize how investors are judging the performance of these funds,” says Bensted. “Preqin’s recent research highlights that investors are not using hedge funds to produce outsized returns, but instead to produce uncorrelated, risk-adjusted returns. Over short and longer time frames, hedge funds have in general met investor needs for risk-adjusted returns. However, 2014 has been a period of relatively turbulent returns when looking at Preqin’s monthly benchmarks; in times like this, investor calls for changes in fee structures and better alignment of interests become more vocal, and this clearly has had an impact on CalPERS’ decision.”