Rosalind M. Hewsenian, managing director and principal at Wilshire Associates Inc., Santa Monica, Calif., said existing institutional-quality hedge fund managers could absorb at most 3% of CalPERS' global equity assets, or $3 billion.
That amount "would pretty much soak up the capacity in the top hedge funds out there," she told the board.
(CalPERS currently has $641 million invested in 13 hedge funds. The fund's target allocation is $1 billion, nearly 1% of its $90 billion global equities program.)
Based on a "back-of-the-envelope" calculation, Ms. Hewsenian said the incremental value to CalPERS' total portfolio would be approximately six basis points. That figure assumes the absolute-return program returns 11%, vs. an 8% expected return from global equities, and assumes a 2% allocation to absolute-return strategies.
Ms. Hewsenian said absolute-return strategies offer more in the way of risk reduction than in added value, explaining that a 2% allocation would result in a 20-basis-point reduction in risk. "The bottom line here is that hedge funds may be more powerful to CalPERS as a volatility reducer than a return enhancer," she said.
Allen Emkin, managing director of Pension Consulting Alliance Inc., Encino, Calif., concurred the CalPERS board will have to decide if the program will have "a meaningful impact on the total portfolio" given the pension fund's immense size.
Noting that the absolute-return program "keeps the staff happy" because hedge fund managers "are more interesting to evaluate," Mr. Emkin said the board "will have to decide whether it's worth the time and energy."
Sean Harrigan, CalPERS president, citing Ms. Hewsenian's incremental return estimate, asked, "Is it worth our time to be engaged in this asset class?" Board member Sidney Abrams raised similar concerns.
However, CalPERS Chief Investment Officer Mark Anson, who has written extensively on hedge funds, said "reasonable people can disagree" with Ms. Hewsenian's expected-return estimate. He agreed that capacity is a key issue.
But many agreed the current mutual-fund industry scandals will drive talented portfolio managers out of traditional shops and into hedge funds.
Echoing comments made by Ms. Hewsenian and Mr. Emkin, Mr. Anson said "there will be a significant drain of talent from the mutual-fund industry … for the next decade or two decades."
Christy Wood, senior investment officer, global equities, said increased scrutiny by the Securities and Exchange Commission on traditional managers that run hedge funds side-by-side "probably will expedite the exodus out of long-only managers."
"To shut down the (absolute-return) program and foreclose the opportunity is not, in my opinion, the best course of action," Mr. Anson added.
Jane Buchan, managing director of Pacific Alternative Asset Management Co., Irvine, Calif., which serves as adviser to CalPERS' absolute-return program, said there is adequate capacity among existing hedge-fund managers.
Carrie McCabe, president and chief executive officer of McCabe Advisors LLC, New York, which is one of CalPERS' absolute-return advisers, disagreed with Ms. Hewsenian's estimate that there are only 400 institutional-quality absolute-return managers. Ms. McCabe said there are 1,200 to 1,500.
"This is the new frontier for active management," she asserted.