On the surface, the argument against hedge funds should be easy — fees are high and they can't hold a candle to public equity returns. But a deeper look shows that hedge funds still pull their weight in the portfolio if the right managers are chosen and the right strategy deployed.
Public funds were studied due to the large set of available data covering more than 100 plans. These plans are still open and investing to meet their obligations where as their corporate counterparts are largely closed and derisking.
[Chart 1: fees and premiums]
Fees have come down since their pre-crisis levels amid pressure from investor outflows and questions about their value compared with public equities.
Seat at the table
[Chart: 1 falling allocations] targets and actuals
Public plans have lowered their hedge fund allocations, but not eliminated them entirely, holding on to mandates for the broad portfolio benefits the funds provide.
A hand up
[Chart 3: down market returns and vol]
Hedge funds still provide downside protection in falling markets, with relatively better returns and less volatility than global equities. Investment-grade debt still reigns in down markets.
[Chart 4: Manager selection]
A review of public pension plan hedge fund returns shows that manager selection is more important when equities are down and hedge fund premiums are positive. Hedge fund portfolio returns deviate more when equities are down and when their equity premiums are positive.