Big public funds outperform their hedge fund yardsticks

Returns of the hedge fund portfolios of large U.S. public pension plans trounced industry and internal benchmarks for the year ended June 30.

Hedge fund returns of large pension funds averaged 11% for the period, handily outperforming the 9.1% return of the HFRI Fund Weighted Composite index, which tracks single and multistrategy hedge funds, and the 4.7% return of the HFRI Fund of Funds Weighted Composite index, which tracks hedge funds of funds.

The public plan hedge fund portfolios, which ranged in size from $5.5 billion to $1.2 billion, also easily beat their internal benchmarks. Benchmark returns of the eight funds ranged from 0.56% to 8% for the year ended June 30. The average policy benchmark return was 4.3%.

The statistics came from Pensions & Investments' first-ever analysis of hedge fund performance of some of the largest public fund investors in the asset class.

Overall fund returns also were higher than hedge fund portfolio returns for seven of the funds. The only exception was the Public School Employees' Retirement System of Pennsylvania, Harrisburg, where the hedge fund portfolio returned 15.6% and the entire fund returned 14.5%.

Hedge fund specialist consultants said the average returns masked the wide variance of one-year returns, which ranged from nearly 16% for a portfolio entirely invested directly in single and multistrategy hedge funds to 7% for a portfolio invested solely in hedge funds of funds.

“There was tremendous dispersion in the returns in this universe, much greater than you would expect,” said Stephen L. Nesbitt, CEO of alternative investment consultant Cliffwater LLC, Marina del Rey, Calif. He noted the P&I data suggest that “direct investment programs did much better” than funds of funds.

The $5.1 billion hedge fund portfolio of the Pennsylvania school employees fund was the top performer on P&I's list with a 15.6% return for the year ended June 30, 170 basis points higher than its nearest competitor. PPSERS is a relative newcomer to hedge funds; its first investments were made March 31, 2009.

The system had $45.9 billion in total assets as of June 30; the fund returned 14.5% for the year.

Its one-year return was generated by 12 single and multistrategy hedge funds. It not only outperformed the HFRI Fund Weighted Composite index, but also was nearly double the fund's 8% annualized policy benchmark.

The diversification and volatility control provided by the hedge fund allocation was just as important as performance, James Grossman, director external markets, risk and compliance at Pennsylvania schools, said in an interview.

“One of our objectives was to find managers that offered returns uncorrelated to other asset classes in our portfolio. We really built the program to diversify risk in our portfolio, especially equity risk,” Mr. Grossman said.

He said the portfolio succeeded at controlling volatility, coming in well below the 8% annualized target since inception set by the staff. “The most important thing was to contain risk and that means that if equity markets are up 40%, I don't anticipate that this portfolio would rise as much, but it also won't go down as much when equity markets fall,” he added.

A number of the pension funds in P&I's universe followed the lead of the $205.5 billion California Public Employees' Retirement System, Sacramento — which began investing in hedge funds in April 2002 — and moved the majority of its portfolio into direct investments in single and multistrategy hedge funds. Its funds of funds investments were narrowed to niche strategies, such as geographic or emerging markets.

Hedge fund consultant Jim Vos noted that hedge fund-of-funds returns for the year ended June 30 include the second half of 2009, when many managers were affected by waves of redemption requests that began in 2008.

“It's very difficult for a portfolio manager to play offense when the fund is getting smaller to meet redemptions. In the year after a big market dislocation, there tends to be a lot of performance dispersion between hedge funds of funds, which lag returns of hedge funds,” said Mr. Vos, CEO and head of research at Aksia LLC, New York.

Combining direct investment and funds of funds, the $3.5 billion portfolio of the New Jersey Division of Investment, Trenton, was second to the Pennsylvania fund in the hedge fund performance stakes with 13.9%. New Jersey began investing in hedge funds in April 2006.

The division's return was the result of a 58/42 split between single and multistrategy hedge funds and funds of funds, but fund staff uses the HFRI Fund of Funds Weighted Composite index as the sole hedge fund benchmark.

The division managed $66.8 billion as of June 30. For the year, the total fund returned 14.4%.

Hedge fund investments of the Missouri State Employees' Retirement System, Jefferson City, returned 12.6%, the third best for the one-year period. MOSERS' hedge fund policy benchmark returned 4.1% for the period. The fund had 24% of total assets invested in hedge funds, the largest percentage in P&I's universe.

The $1.7 billion MOSERS portfolio had a 74% exposure to direct investments largely through its portable alpha program, said Christine Rackers, MOSERS spokeswoman. MOSERS had defined benefit assets of $7 billion as of June 30. Total fund return for the year was 14.3%.

The $1.2 billion absolute-return portfolio of the Teachers' Retirement System of the State of Illinois proved that size was not a prerequisite for good hedge fund performance in P&I's universe. The portfolio returned 11.1% for the year, beating the 4.99% return of its policy hedge fund benchmark, and earning fourth place in P&I's ranking. TRS had 26% of its allocation in direct investments and 74% in funds of funds.

The Springfield-based fund had total assets of $33.1 billion as of June 30. The total return for the year was 13.3%.

With the entire $4.7 billion hedge fund portfolio invested in funds of funds, the Pennsylvania State Employees' Retirement System, Harrisburg, was fifth in the ranking, with 9.9%. PennSERS' hedge fund policy benchmark returned 3.3% for the period. PennSERS managed a total of $23.7 billion as of June 30, and the fund's one-year return was 12.6%.

Sixth in the ranking was $5.5 billion hedge fund portfolio of CalPERS, at 9.8%. CalPERS' hedge fund benchmark returned 6% for the period. That portfolio had 73% invested directly in single and multistrategy hedge funds, with the balance in hedge funds of funds specializing in Asian, European and emerging manager investments.

CalPERS had total assets of $200 billion as of June 30. For the year, its overall return was 11.6%.

The Teacher Retirement System of Texas, Austin — with 81% of its $4 billion hedge fund portfolio invested directly in hedge funds and the balance in funds of funds — was seventh, with 7.7% for the year. The hedge fund policy benchmark returned 2.35% for the same period. The fund had $92.3 billion in total assets as of June 30. The fund also had the highest overall fund return — 15.6% — among P&I's assemblage for the year.

In eighth was the Massachusetts Pension Reserves Investment Management Board, Boston, with a 7.1% return, which towered over the 0.56% return of PRIM's hedge fund policy benchmark for the period. The fund had $3.2 billion in the portfolio, all invested in hedge funds of funds. PRIM's assets stood at $41.3 billion as of June 30. The fund returned 12.8% for the period.

(Full hedge fund portfolios, including June 30 performance and assets under management by each manager for both the Pennsylvania Public Employees' Retirement System and CalPERS are available online at pionline.com/pennhedge and pionline.com/calpershedge, respectively.)