The ascendancy of institutional hedge fund investors has been a topic of discussion since disappointing hedge fund returns last year, but sources said CalPERS is the first to attempt to completely remake its portfolio with much better investor terms and lower fees.
Fund executives issued something of a manifesto to the hedge fund industry in a March 27 news release. “We believe that investors and managers alike stand to benefit over the long term when interests are better aligned, asset controls are properly instituted and transparency of risks and exposures is improved. We look forward to working with hedge fund managers in the coming months to strengthen these concepts and make hedge funds an even more effective asset management tool in the CalPERS portfolio,” Chief Investment Officer Joseph Dear said in the release.
“It's in our interest to get the best possible return on investment for our members, but it's in the managers' interest to be more closely aligned with CalPERS in building stronger, more stable relationships,” Mr. Silberstein said in the release.
Materials given to board members and available on CalPERS' website about the April 20 meeting provide a detailed look at a mature hedge fund portfolio that's about to move to a structure unique in the pension world.
CalPERS' existing hedge fund portfolio outperformed the HFRI Fund of Funds Composite index in six of the seven years since the portfolio's inception in April 2002, according to agenda information.
And the materials point out to trustees that “alpha is expensive,” given that hedge fund management, performance and advisory fees paid by CalPERS in 2008 totaled about $135 million, making the case for the staff goal to spend less on management fees and more on performance fees. One way to reduce costs is through the use of so-called hedge fund replication strategies, something staff is “exploring,” according to the board papers.
The materials detail how the staff will achieve lower management fees as well as other investment concessions. CalPERS staffers now are at work implementing plans to change the terms of each of the 26 direct hedge fund investments to incorporate:
• complete control over investments through a CalPERS-specific separate account that eliminates gates, suspensions and side pockets, and allows staff to immediately stop trading to protect assets;
• lower fees, with the addition of a delayed payout and hurdle rates to reward long-term performance; and
• full position-level transparency for the 10% of hedge fund managers that don't provide it now.
Staff currently is vetting separate-account investment platform providers with a view toward getting a new system in place within a few months.
Managers will be required to comply with all demands or face termination, Mr. McKinley said. The nine-person CalPERS hedge fund team has informed all managers of the new requirements, but no contracts have been signed yet.
The fate of the nine hedge fund-of-funds managers, which managed $1.3 billion or 22% of the absolute return portfolio as of March 1, was not clear from the documents, and Mr. McKinley was unable to provide additional details.
Hedge fund consultant Aoifinn Devitt said many of her pension fund clients are talking about restructuring their relationships and moving to separate accounts, but CalPERS is the first fund to propose the move and push their managers for better terms. Ms. Devitt is a principal at London-based Clontarf Capital.
“There are a couple of hedge fund-of-funds managers that are moving to all separate accounts for their underlying managers, but not pension funds. And hedge funds of funds have for some time been able to negotiate for more investment control, more transparency and lower fees. It makes sense that CalPERS, with its large portfolio, would follow in the footsteps of hedge funds of funds,” Ms. Devitt said.
But other industry observers warned it's unlikely that all 26 managers will acquiesce to CalPERS' demands.
“They want to invest in the best hedge funds, but among the best hedge funds there still are quite a few closed doors, because these funds simply don't need the assets,” said alternatives consultant Stephen L, Nesbitt, CEO of Cliffwater LLC, Marina del Rey, Calif. “Many of these coveted managers don't need to make concessions.”
Mr. McKinley admitted “it is a distinct possibility (that) some hedge funds will opt out of improving the partnership with CalPERS.” Still, he said, fund executives “believe there are many very good hedge funds which understand the direction the hedge fund industry is going and will gladly be the recipient of the institutional assets that will seek those hedge funds that strive to better align themselves with their investors.”