The board of the $20 billion San Francisco City & County Employees' Retirement System is expected in the next several weeks to reject Chief Investment Officer William Coaker's plan for a 15% allocation to hedge funds and instead reduce the allocation to no more than 5%, sources say.
The board is also expected to bar or severely limit the use of leverage by hedge fund managers, a common strategy to increase returns.
Mr. Coaker's plan would shift assets from fixed income and equities to create the pension fund's first hedge fund allocation.
The outcome of the San Francisco vote is taking on more significance than it might have in the past. That's because of the decision by the $293.7 billion California Public Employees' Retirement System in September to end its $4 billion hedge fund program.
“Every institutional investor had taken note of the CalPERS decision,” said Doug Smith, a New York-based senior investment consultant for Towers Watson & Co., who doesn't do work for San Francisco or CalPERS.
Mr. Smith said CalPERS' action has caused institutional investors to give more thought to their hedge fund exposure, analyzing “gross alpha” as they try to determine how much of their hedge fund performance is due to manager skill as opposed to market gains.
Mr. Smith, a supporter of hedge fund investment, said too often the fees are weighted in favor of managers, eating up much of the excess alpha being generated.
Costs that used to be as high as a 2% management fee and 20% of profits have come down in many cases to a 1.5% fee and 15% of profits, but even under that scenario, investor profits can be elusive, he said.
Towers Watson recommends that that fees make up no more than one-third of the gross alpha and that gross alpha be separated from overall alpha to determine what portion of the return is due to manager skill, Mr. Smith said.
He said the allocation to hedge funds should be at least 10% of assets in order to be a sufficient hedge and diversifier for the rest of the investment portfolio.