SACRAMENTO, Calif. -- The decision by CalPERS executives to pump up to $14 billion into aggressive investments including hedge funds will spur smaller public pension funds to follow.
And Robert Schulman, president of Tremont Advisors, New York, a hedge fund consulting firm, predicted the CalPERS move eventually could prompt hedge fund managers to operate differently.
"Probably most pension funds would invest in hedge funds through separate accounts, in order to get the kind of transparency and liquidity that they require," he speculated. Pension funds probably will set limits on the types of investment vehicles they can use, driving hedge fund managers to operate in a more traditional way.
"We could wind up with a second industry of hedge fund managers servicing the pension community, offering blended products," he said.
Only 2% of public pension funds use hedge funds now and 7% are considering it, said Rodger Smith, president of consultant Greenwich Associates, Greenwich, Conn.
Mr. Smith and Russ Kamp, product manager for the structured products group at INVESCO, Atlanta, believe public funds will follow CalPERS' lead in looking seriously at hedge funds. One reason, Mr. Kamp said, is U.S. equities might not continue to yield the double-digit returns they have in the past few years.
Sheryl Pressler, chief investment officer at the $160 billion California Public Employees' Retirement System, said no plan has been formally approved. The fund is looking for strategies that add value, she said.
"We don't have targets or a policy at this point," Ms. Pressler said. "We asked the board for the leeway to potentially look at higher-producing investments to bring to the investment committee. We're just dipping our toes in the water at this point."
She noted that while the industry calls many of these investments hedge funds, CalPERS calls them hybrids. The system plans to avoid highly leveraged vehicles that involve short selling. It will be looking at hybrid investments such as market neutral, arbitrage and crossover funds. It already has $900 million invested in corporate governance funds.
"We won't invest in these through separate accounts because we want to limit the liability to the system, so they will be set up as limited liability vehicles," Ms. Pressler said.
Staff recommended investing up to 25% of its $45 billion actively managed U.S. portfolios -- or $11 billion -- and up to 25% of its $13 billion actively managed international portfolios, or $3.2 billion, in various kinds of hybrids. But the actual commitments are unlikely to approach that level for several years, noted Brad Pacheco, spokesman for the fund.
"The initial allocation would be under 5% of those portfolios, or $2.8 billion. If the funds perform as they are expected to over time, the amount of the allocation could then approach as much as 25%," he said.
In August, CalPERS trustees approved the fund's first hedge fund investment -- up to $300 million in Pivotal Partners, San Francisco. Pivotal, which plans to raise $500 million, will invest in growth companies, focusing on technology.
CalPERS' hybrid investment program will be overseen by the system's three senior principal investment officers for equity and senior principal investment officer for fixed income. They will do preliminary evaluations.
Consultant Wilshire Associates, Santa Monica, Calif., will do the analysis and due diligence, Mr. Pacheco said. There are no plans to add staff.
Most of the institutional money flowing into hedge funds traditionally has come from endowment funds and corporate pension funds, but not public pension funds.
The $11 billion defined benefit plan at World Bank, Washington, for example, has been investing in hedge funds since 1982, said Jin Park, investment officer. It has 1% of assets in the asset class. Two-thirds is invested in a distressed opportunities fund in Japan; and the remainder is invested in a fund that takes an event-driven global-macro approach. World Bank's strategy is to create a portfolio with better risk-adjusted returns on a more opportunistic basis by identifying styles that will best traditional managers.
World Bank has been interviewing managers for long-short strategies. Next it will interview event-driven managers, then arbitrage managers. Mr. Park said the bank has no target policy for hedge funds at this time.
He added there is a serious lack of good hedge fund managers and that some are running too much money.
That could mean trouble for CalPERS and other big pension funds if they want to invest large sums in the asset class. "If CalPERS has $1 billion to invest in hedge funds, it could take a year to find managers without diluting the returns. There is not enough capacity," he emphasized.
Hedge fund fees are high, averaging 1% to 2% management fees plus another 20% of profits. But consultants said the fees could drop if giant funds such as CalPERS put on the pressure. Mr. Pacheco said CalPERS officials intend to negotiate lower fees. "We acknowledge that they are higher than those of traditional managers, but we expect that the better returns will justify the higher fees," he said.
