Last Monday, the largest U.S. public pension plan, known by the abbreviation Calpers, announced its decision to exit hedge funds, saying they are too expensive and complex. The pension fund disclosed it paid $135 million in hedge fund fees in the fiscal year ending June 30. Calpers’ investment return goal is 7.5 percent, yet over the last ten years, the average annualized rate of return on its hedge fund investments was just 4.8 percent.
The Wall Street Journal reported other pension funds were debating whether to follow Calpers’ lead and avoid hedge funds altogether. Last week, the San Francisco City & County Employees Retirement System delayed for another 90 days a decision on whether to allocate 15% of its money to hedge funds. It is the second such delay this year.
Could this decision be the start of a trend? Has the magic gone out of hedge funds?
We don’t think hedge funds do anything different than normal investment funds, except that they are not subject to any constraints on their investment activities. The mystique surrounding hedge funds may stem in part from their secrecy, as many are reluctant to share their investment formulas. The typical hedge fund fee structure – 2% of assets plus 20% of any profits – also may contribute to the misconception that hedge fund moguls are magicians.
We don’t believe in fairy tales. Last year, GV’s Investment Committee researched extensively looking for hedge funds, hedge funds platforms that could add value to the client portfolios. We decided against investing in them given their complex structures, lack of liquidity, and most importantly, their high cost structures.
Hedge funds are certainly a viable strategy for some. Obviously, not all hedge funds are created equal, and some are actually generating some excess returns. However, we also hear about hedge fund clients plagued by high fees, complex legal structures, poor disclosure, and potentially meager investment returns. We think it seems virtually impossible to identify which hedge funds will be winners and which ones will be losers in advance. Our decision to avoid hedge funds has nothing to do with ego or emotion. We always go back to the maxim: only invest in what you understand and if the potential reward is worth the risk.