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Healthy growth of hedge fund assets continuing among DB plans

Public funds pouring more into asset class while some corporate funds trim sails a bit

Assets invested in hedge funds by defined benefit plans grew faster than any other large alternative investment asset class in the year ended Sept. 30, according to data from Pensions & Investments' annual survey of the nation's largest retirement funds.

P&I's survey results chart the ongoing move into direct hedge fund investments from hedge funds of funds by many large pension funds. More narrowly, the data demonstrate that even as public pension funds played catch-up in building their hedge fund portfolios in the year ended Sept. 30, a fair number of corporate plans significantly reduced their portfolios.

“Public pension plans are the third wave of significant institutional hedge fund investors after family offices and endowments and then corporate pension plans. They still are moving a lot of money into hedge funds,” said Joseph F. Gieger, managing director, Americas, at hedge fund and hedge funds-of-funds manager GAM USA Inc., New York.

“Public funds that were at the front end among their peers in investing in hedge funds of funds now are moving directly into hedge funds, Mr. Gieger added.

Assets directly invested in single- and multistrategy hedge funds leapt 15.1% to $115 billion as of Sept. 30 from $100 billion on the same date a year earlier.

Hedge funds-of-funds investments by defined benefit funds among the 200 largest retirement plans, on the other hand, declined 3.1% to $35 billion in the year ended Sept. 30.

The combined $150 billion total of direct hedge fund and hedge funds-of-funds investments as of Sept. 30 represented a 10.3% rise from the prior year.

Despite strong growth in hedge fund investments as of Sept. 30, the alternative investment category represented just 3.4% of the $4.5 trillion of defined benefit plan assets of the 200 largest U.S. retirement funds, up from 3.3% the prior year. Assets of the 200 largest defined benefit plans overall rose 9.7% in the year.

Growth of DB assets in hedge funds

As for other alternative investments, private equity investments by the 200 top funds essentially were flat, ending the one-year period at $314 billion, up just 1.1%. Distressed debt, a comparatively small subasset class of private equity at $25 million, was up 37.3% in the year ended Sept. 30, while the still smaller stand-alone energy asset class grew 58.7% to $12 billion in the same period.

On an individual basis, 45 of the 74 defined benefit plans that reported hedge fund investments on P&I's survey showed positive growth in percentage terms in their portfolios in the year ended Sept. 30 ranging from 399% to 0.2%, while 20 plans reduced hedge fund exposure in a range from between -0.9% to -77.4%. Eight funds were new to the 2013 hedge fund ranking and one pension fund's assets did not change.

Largest DB investors

The five largest defined benefit investors in hedge funds according to P&I's survey were led by the $119.7 billion Teacher Retirement System of Texas with $10.6 billion as of Sept. 30, up 9.8% from $9.7 billion the prior year. By comparison, the Austin-based fund's hedge fund portfolio grew 109.7% in the year ended Sept. 30, 2012, as the fund's investment staff worked to invest an additional 5% allocation in hedge funds to bring the total investment up a 9% target. All of TRS' assets are directly invested in hedge funds.

The New Jersey Division of Investment, Trenton, moved to second place from third in the hedge fund ranking with a total of $7.5 billion — $5.2 billion invested directly in hedge funds and $2.3 billion invested in funds of funds on behalf of the state's $75.3 billion defined benefit plan. The total hedge fund portfolio was up 28.1% as of Sept. 30 compared to a year earlier. The division also has been building the hedge fund portfolio over the past two years; hedge fund assets were up 28.1% in the year ended Sept. 30, 2012.

In the third position, the Pennsylvania Public School Employees' Retirement System, Harrisburg, was alone among the five largest hedge investors to have reduced the size of its portfolio by 4.5% to $6.6 billion in the year ended Sept. 30. By contrast, the all direct-invested portfolio of the $48.9 billion defined benefit plan grew 23.6% in the 12 months ended Sept. 30, 2012.

The $164 billion New York State Common Retirement Fund, Albany, had the greatest growth — 55.7% — among the five largest hedge fund investors, with $5.5 billion directly invested in hedge funds as of Sept. 30. The significant increase in hedge fund assets propelled the Albany-based fund into fourth place in the rankings, up from 12th in the year-earlier survey. Hedge fund asset growth was much lower in the year ended Sept. 30, 2012, at 7.5%.

Texas County & District Retirement System, Austin, rounded out the quintet of the largest investors with $5.4 billion directly invested in single- and multistrategy hedge funds as of Sept. 30, up 13.1% from the prior year. The $21.7 billion defined benefit plan's hedge fund portfolio grew 22.4% a year earlier.

While public pension plans accounted for 20 of the 25 funds that experienced the highest growth in hedge fund assets in percentage terms during the year ended Sept. 30, corporate pension plans were more evident among the 20 funds that reduced the size of their hedge fund portfolios.

Funded status and LDI

Sources said the difference between the current hedge fund investment patterns of the largest plans boils down to funded status levels and liability-driven investment strategies.

U.S. public pension plans “are worse off when it comes to meeting their bogey because they can keep kicking the can down the road,” said M. Sa'ad Shah, managing director at hedge funds-of-funds manager Diversified Global Asset Management Corp., Toronto. “Public pension plans are looking for sources of higher, uncorrelated returns in order to increase the plan's funded status and continue to look to hedge funds to provide it.”

The funded status of corporate defined benefit plans, on the other hand, must be reflected on company balance sheets, which compels chief financial officers to lean on pension staff to reach full funding as quickly as possible and then to protect that status through LDI.

Strong stock markets globally have left corporations “in a very strong position, flush with cash. Many companies have used surplus cash to improve their plan's funded status,” said Mr. Shah.

As part of derisking the portfolios of their now healthier defined benefit plans, Mr. Shah said, “a lot of corporations are taking their hedge fund exposures down.”

The resulting reductions in the size of corporate plans' hedge fund portfolios show up clearly in P&I's survey results.

The $12.2 billion defined benefit plan of PG&E Corp., San Francisco, had the largest decline in its hedge fund portfolio in percentage terms among corporate plans in P&I's universe at 55.3% to $226 million for the year ended Sept. 30, followed by:

Although Boeing spokesman Charles N. Bickers declined to elaborate on the specifics of the sharp decline in hedge fund investments within the company's defined benefit plan, he did say it was “part of the long-term change to invest hedge fund assets directly.”

Boeing's hedge fund assets totaled $5 billion as of Sept. 30, 2012, $3.9 billion of which was invested directly in single- and multistrategy hedge fund and $1.1 billion was in hedge funds of funds.

This article originally appeared in the February 3, 2014 print issue as, "Healthy growth continuing among DB plans".