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  2. ALTERNATIVES
August 18, 2014 01:00 AM

Hedge fund investing strong in 2014

Headline-making cutbacks raising questions, but most investors stay the course

Christine Williamson
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    As institutional investment in hedge funds matures, most investors have been busy starting, growing, optimizing and fine-tuning their hedge fund portfolios.

    A few institutions, however, have drastically cut or completely axed their investment in hedge funds.

    Among the small cadre of investors that have decreased or dropped hedge fund investments are the $298.4 billion California Public Employees' Retirement System, Sacramento; the $18.3 billion Los Angeles Fire & Police Pension System; the $11.3 billion New Mexico Educational Retirement Board, Santa Fe; £1.6 billion ($2.7 billion) Oxfordshire County Council, Oxford, England; and the $1.3 billion Louisiana Firefighters' Retirement System, Baton Rouge.

    While some of 2014's most attention-grabbing headlines, including Pensions & Investments' May 12 “CalPERS chopping hedge fund allocation” headline, have focused on the asset owners cutting back on hedge funds, industry sources said they aren't seeing a widespread move away from the asset class.

    “We are not seeing a trend in that direction,” said Brian Kmetz, assistant vice president, hedge fund research, for investment consultant Callan Associates Inc., San Francisco.

    In fact, most institutional investors, including public pension funds, endowments, foundations, insurers and sovereign wealth funds, have maintained or steadily increased their investments in hedge funds and hedge fund strategies.

    Hedge fund search and hire activity, particularly by first-time hedge fund investors, has been strong so far this year, a review of Pensions & Investments' reporting showed.

    Among recent first-time hedge fund investors and searchers:



    • Illinois State Universities Retirement System, Champaign, will soon begin a search for either hedge fund or fund-of-funds managers for a new 5% allocation for the $16.9 billion defined benefit plan it oversees;

    • The $5.1 billion City of Milwaukee Employes' Retirement System hired Allianz Global Investors to manage $62.5 million in an absolute-return strategy in July; and

    • The $1.1 billion St. Paul (Minn.) Teachers' Retirement Fund Association hired EnTrust Capital Management LP to manage $55 million in a customized hedge fund-of-funds separate account in May.

    Other institutional investors have spent the first part of 2014 pushing their portfolios farther down the hedge fund evolutionary path by adding diversifying niche strategies.

    The $14.6 billion Illinois State Board of Investment, Chicago, seeks to diversify its $1.5 billion hedge funds-of-funds portfolio by moving as much as $150 million into a customized emerging hedge fund manager portfolio from existing hedge funds-of-funds managers.

    Even as the majority of institutional asset owners stay on course with their hedge fund portfolio development, the fact that one of the longest-tenured and largest of institutional hedge fund investors — CalPERS — has been stealthily halving its $5 billion portfolio throughout 2014 (P&I, May 12) has made some institutional chief investment officers edgy, sources said.

    A hedge fund consultant, who asked not to be identified, said CalPERS' decision to slash its hedge fund allocation “clearly is (raising) questions” among the consultant's large European pension fund clients.

    CalPERS' investment executives have been focused on reducing hedge fund fees since at least 2009, when staff stated their intention to renegotiate the fees and terms of the contracts of hedge fund and hedge funds-of-funds managers in the portfolio, (P&I, April 20, 2009).

    “Fees are always on the table,” said Mr. Kmetz, noting Callan has had success in bargaining down hedge fund fees for clients.

    Mr. Kmetz maintained that hedge funds have been “performing up to our expectations” since the 2008 financial crisis, despite the “trumpeting of all the supposed virtues” of high hedge fund performance.

    “Obviously, people have expected a lot more” from hedge funds in terms of returns, Mr. Kmetz said, but added that “with hedge funds, you have to manage expectations and focus on the diversification and hedging protection they offer portfolios.”

    That said, a select few institutions have recently ended their experiment in hedge fund investing.

    Dropping hedge funds

    Among the funds that completely eliminated hedge funds is the Los Angeles Fire & Police Pension System. The $18.3 billion fund began redeeming its $549 million portfolio in May 2013, because the overall portfolio needed to be more diversified and hedge fund fees were just too high, Emanuel Pleitez, a trustee of the Los Angeles Fire & Police fund, said in a video interview with P&I in June.

    “If you look at hedge fund fees on a risk-adjusted basis ... (remaining in hedge funds) wasn't justified. We need to show that we are willing to walk away from managers that are charging us exorbitant fees,” Mr. Pleitez said.

    LAFPP investment officials project a $13 million savings in management fees from the elimination of hedge funds, although $6.5 million of those fees will be reallocated to other asset classes, according to documents from the board's March 20 meeting.

    After losing a $45 million investment in the Fletcher Income Arbitrage Leveraged Fund when its manager, Fletcher Asset Management, declared bankruptcy in 2012, the Louisiana Firefighters' hedge fund allocation was down to 0.6% of plan assets, or just $8 million. The original hedge fund allocation of 5% was removed from the plan's overall asset allocation in March.

    An asset allocation review in March eliminated the 3% hedge fund allocation of the Oxfordshire County Council Pension Fund. UBS Global Asset Management is the sole manager of the pension fund's £35 million hedge fund portfolio.

    According to a report from the fund's June 6 board meeting, the proceeds of the elimination of the 3% hedge fund allocation and a four percentage point decrease in the equity target to 59% of plan assets will be reallocated to infrastructure and growth funds.

    A new asset allocation approved in June for the New Mexico Educational Retirement Board eliminated a 3% target allocation to hedge funds, but didn't eliminate hedge funds, said Bob Jacksha, chief investment officer, in an interview.

    Instead, NMERB joined CalPERS and other large investors regrouping hedge funds with other like investments, whether they are in traditional asset class buckets or broader groupings such as opportunistic or diversifying assets.

    “We do use hedge funds in other areas,” Mr. Jacksha said, noting Bridgewater Associates LP's Pure Alpha Fund resides in the system's global tactical asset allocation slot and credit hedge funds remain in the opportunistic category.

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