Analysis of returns collected by P&I showed 57% of public pension hedge fund portfolios topped their benchmark returns as of Sept. 30 compared with 81% a year earlier.
The difference of 760 basis points between the 1.5% median return of the hedge fund portfolios in P&I's universe as of Sept. 30, 2015, and the 9.1% median return the year earlier reflects the Jekyll and Hyde performance turnaround for hedge fund strategies from one year to the next, sources said.
The 1.7% decline of the HFRI Fund Weighted Composite index for most recent period, for example, was in sharp contrast to the 6.4% index return the prior year.
Ditto for major equity market indexes: The one-year return as of Sept. 30 for the S&P 500 was -0.6%, but for the year-earlier period was 19.7%; the MSCI ACWI dropped 6.1% in the year ended Sept. 30 and rose 11.9% the prior year.
Despite strong headwinds, nearly every state pension plan's hedge fund portfolio reviewed by P&I did outperform the HFRI Fund Weighted composite returns in 2015, as they did in 2014.
The return of the Texas Teachers directional portfolio lagged the index in 2015. In 2014, the 2.5% return of the $3.3 billion hedge fund portfolio of the $84.5 billion Wisconsin State Retirement System Core Fund, Madison, was behind the index return that year.
However, neither the Texas Teachers nor the Wisconsin hedge fund portfolio is designed to outperform the HFRI index. Rather, the portfolios have been constructed to provide positive returns in all market environments.
Texas Teachers, for example, divides its total $7.8 billion total allocation to hedge funds into the directional portfolio, which is designed to do well in strongly positive markets, and a non-directional portfolio, which is expected to perform well in down markets.
As of Sept. 30, Texas Teachers' non-directional portfolio held 67.7% of the pension fund's hedge fund assets and its 4.3% one-year return was the fourth best in P&I's ranking. In 2014, the hedge funds portfolios' positions reversed: the directional portfolio ranked fifth in the ranking with a 9.4% one-year return, while the non-directional portfolio ranked 12th.
Juliana Hernandez Helton, a Texas Teachers spokeswoman, did not provide comment about the pension fund's hedge fund returns by press time.
“Hedge funds largely preserved capital in 2015,” said Stephen L. Nesbitt, CEO of alternative investment consultant Cliffwater LLC, Marina del Rey, Calif., in an e-mail. He noted that Cliffwater researchers have calculated positive alpha production of one to three percentage points by most public pension plan hedge fund portfolios in 2015.
Producing a positive return — however small — in a hedge fund portfolio in 2015 was no easy feat.
“For many in the hedge fund industry, 2015 is shaping up as the worst year since 2011, if not since 2008,” according to researchers at industry tracker eVestment LLC, Marietta, Ga., in their third-quarter hedge fund performance review.
The reason — at least in part — for both the decline in hedge fund portfolio returns in 2015 and healthier 2014 performance was the same, sources said: an abundance of market beta in pension funds' portfolios.
“In aggregate, poor 2015 numbers compared to 2014 numbers were heavily influenced by MSCI ACWI returns. Most state hedge fund portfolios do have some beta, and (that is) partly responsible for differences in yearly results,” Cliffwater's Mr. Nesbitt said.
Jonathan Grabel, chief investment officer of the $14.4 billion Public Employees Retirement Association of New Mexico, Santa Fe, was more emphatic about the influence of market beta on hedge fund strategy performance.
“Equity beta absolutely screams through 2015 returns, especially in the third quarter,” Mr. Grabel said, adding “we don't need any equity beta exposure in the hedge fund portfolio. We have plenty of that in our public equity portfolio where we pay a lot less for it.”
New Mexico PERA has spent this year “significantly restructuring” its hedge fund portfolio to scrub out sources of market beta and downsize from a nearly 8% allocation to 4%, $730 million in current dollars, Mr. Grabel said. The portfolio returned -0.7% in the year ended Sept. 30 and 9.2% the prior year.