Nearly two years after its highly publicized withdrawal from the hedge fund asset class, the California Public Employees' Retirement System reported a 0.61% net return on investments for its fiscal year ended June 30. While the giant pension fund's decision may have had only a small effect on its performance, what we know is that it did not help the fund.
CalPERS had $463 million in its hedge fund program at the end of last year.
With bond yields at historic lows and stocks reaching bubble territory by many measures, the only way pensions funds like CalPERS are going to come close to meeting their funding goals is by investing in strategies that produce alpha. There's no way around it.
CalPERS' decision has had ramifications throughout the investment management sector, spurring other pension funds to rethink their own hedge fund strategies. Recently, the New Jersey State Investment Council decided to cut the New Jersey Pension Fund's hedge fund target allocation in half, to 6% of assets, and the New York City Employees' Retirement System voted to get out of hedge funds entirely. A reduction in investors' hedge fund holdings, as well as the underperformance of many hedge funds, has led to the closing of many funds in recent months. Hedge fund liquidations outpaced launches in the first two quarters of 2016, with 372 funds closing through June, according to the Eurekahedge Report.
This tendency toward a wholesale pullback from hedge funds ignores a major challenge faced by almost every pension fund today. Given the underfunded status of many funds, it will be nearly impossible for them to generate sufficient return to meet their long-term return assumption — generally about 7.5% — using a conventional portfolio mix.
To underscore this point, Callan Associates Inc. in May estimated that a long-only investor seeking a 7.5% total return must take three times the risk today compared with 1995. In 1995, that investor could construct a 7.5% total return portfolio entirely from bonds. Today, that same return might require a mix of debt, large-cap equity, small-cap equity, real estate and private equity, according to a 2016 Global Hedge Fund Report, released by Preqin in July.