Even before the dramatic decision to significantly reduce its reliance on hedge funds and to cut hedge fund fees, the $71.5 billion New Jersey Pension Fund had been chipping away at those costs.
“We've been getting more aggressive and using our buying power to negotiate fees,” said Brendan Thomas Byrne Jr., chairman of the New Jersey State Investment Council, in an interview Aug. 4, the day after the council voted unanimously for several hedge fund policy changes. “Our average management fee is slightly under 1.5% and the incentive fee is around 18.5%.”
The traditional hedge fund formula is 2% and 20%, but the investment council unanimously voted for a new policy that requires a 1% management fee and 10% incentive fee for future hedge fund investments.
Mr. Byrne said he believes there are enough high-quality hedge fund managers who will accept the new policy called FAIR, or fund alignment and incentive reform. “People are still going to have to show us performance,” Mr. Byrne said.
New Jersey's decision contrasts with those of the New York City Employees' Retirement System — one of the five funds in the city's $163.1 billion pension system — and the $302.7 billion California Public Employees' Retirement System, Sacramento. Governing boards for both pension funds have voted to divest all hedge funds.
“We didn't want to throw out the baby with the bathwater,” Mr. Byrne said. “We didn't want to abandon an entire category if some investments made sense.”
The policy changes could produce $127 million in annual cost savings “once portfolio restructuring is complete,” said an Aug. 3 report by the Division of Investment. “On a pro forma basis, the division projects a 60% reduction in management fees and a 73% reduction in incentive fees.” A date for completion of the restructuring was not provided.
Another policy change approved by the council affects risk-mitigation strategies, whose asset managers now will be subject to a flat fee of 0.75% to 1.25% and no incentive fee.
The council approved reducing the number of hedge funds to fewer than 25 from about 40. The number “would be further consolidated in order to reach the proposed target allocation for fiscal year 2017,” said the Division of Investment report.
The overall hedge fund target allocation would shrink to 6% from the 12.5% target for the 2016 fiscal year.
The target allocation to risk-mitigation hedge funds — market neutral and global macro funds — remained at 5%. However, the allocation to equity-oriented hedge funds was cut to zero from 3.75%, and credit-oriented hedge funds, cut to 1% from 3.75%.
These allocation targets were proposed by the Division of Investment. Mr. Byrne said the council agreed to divest equity hedge funds because of poor performance. “We couldn't justify the fees,” he said.
According to the division's May 31 investment report, the equity hedge fund portfolio returned -11.98% for the 10 months ended April 30 vs. the benchmark's-5.14%. (The portfolio reports on a one-month lag.)
As of May 31, the investment report shows, the risk-mitigation portfolio produced a return of -2.21% compared to a benchmark of 2.94%. Credit-oriented hedge funds produced a return of -3.24% vs. a benchmark of -7.15%, as of May 31.
As of May 31, the combined market value of the three hedge fund categories represented 11.75% of total pension fund assets.