Every action has consequences. The CalPERS divestiture will have some unanticipated consequences as well. Here are a few.

Doors that May Have Closed

  • Two and twenty was already on the rails and headed out of town before the CalPERS announcement. One of the industry’s worst kept secrets is that most large pension funds and institutional investors are already receiving a sweeter deal than the over-publicized two and twenty fee structure.  None-the-less, media attention surrounding this redemption will serve to grease the rails.
  • CalPERS may have revealed its soft underbelly. As the largest public sector pension fund, it was viewed to have held some sway over smaller pension fund managers. However, recent events have demonstrated that CalPERS leadership role was exaggerated, as evidenced by the legion of ebullient public pension fund managers who have spoken out in support of their hedge fund investments. For example, the California State Teachers’ Retirement System (CalSTRS) has affirmed its intent to stand by the hedge fund investments it has made. This suggests that rather than having been a leader, CalPERS has just been sonorous.

Doors that May Have Opened

  • Public employee pension funds are highly political entities. The complexities of hedge fund investments are not well understood by rank and file public servants who rely on their pension fund for retirement income. However, they do understand is fees and pension fund managers have clearly demonstrated their understanding of the positive role hedge fund investments play in a comprehensive investment strategy. Politics and pensioners may incent fund managers to explore investments in smaller hedge funds with proven track records and more palatable fees. This bodes well for many of the smaller hedge funds.
  • Hedge funds, in the main, are very likely to benefit from this ‘dust-up”. Publicity. Even bad publicity can be good. Hedge funds, now liberated from the decades old general solicitation ban, may see an organic bloom of interest from the retail market. Why? Because the CalPERS split with hedge funds piqued a broader interest in the industry, which may help hedge funds with retail ambitions. Broadly, hedge funds will benefit from the in-depth explanations public pension funds have been compelled to offer in support of their decision to remain invested in hedge funds.

Hedge fund managers need to recognize the doors of opportunity are opening, post CalPERS, and cross those thresholds with alacrity. Managers of smaller hedge funds have a unique opportunity to enhance market share in the public pension sector and they would be ill-advised to pass it by.

Managers of large and small funds would be well-advised to capitalize on the free and favorable publicity proffered by the heads of public pension funds. Large numbers are disavowing CalPERS strategy of divestiture. The cases they have made in support of their positions in hedge funds can be folded into any hedge fund’s retail strategy. Couple this with the rather cogent rationale for hedge fund investment, as articulated by so many public pension fund investors, and you have a powerful marketing tool at your disposal … for free.

 

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CalPERS: Why All the Fuss?

September 28, 2014

Much has been made of California Public Employees’ Retirement System’s (CalPERS) decision to redeem some $4 billion of its assets from hedge fund investments. However, less is made of the fact that CalPERS manages some $300 billion in funds. This means that CalPERS had slightly more than 1% of its assets under management invested in hedge funds, so the real question is … why did they bother?

Perception is Everything

Is the redemption of $4 billion in a $3.1 trillion hedge fund industry truly that consequential? After all, hedge funds attracted more than three times that amount in new money just in the month of August. Massachusetts has $5.6 billion invested in hedge funds, a much larger investment than CalPERS. Yet California has attracted all the press because of its decision to pull out.

While the CalPERS’ redemption will be largely without consequence to any hedge fund’s bottom line, the perception that hedge funds are in any way failing their clients, could have serious consequences. This perception, however false it may ultimately prove to be, is why hedge funds need to be concerned about the CalPERS decision. To quote the Chief Investment Officer of CalSTRS (California State Teacher’s Retirement System, Christopher Ailman, “that industry definitely has a perception problem” Worth noting – CalSTRS has no current plans to redeem its hedge fund investments. 

The CalPERS determination has attracted attention because it was among the first pension fund to test the hedge fund waters and like many other California icons, it has a disproportionate influence among its peers.

Hedge Funds Need to Respond

CalPERS’ prominence as a pioneer in hedge fund investment places it in a unique position to undermine the hedge fund industry’s preeminent role among institutional investors. No doubt, this is the principal driver for those hedge fund managers who have, albeit anonymously, spoken out.

There have been two primary rebuttals. The first purports that CalPERS chose the wrong hedge funds. Therefore, the redemption reflects on the selected hedge funds rather than the industry as a whole. While this argument makes a good sound bite, it falls short of the quantitative argument necessary to keep other institutional investors in the fold.

The second argument, marginally compelling, defines the thirty or so hedge funds employed by CalPERS as poor performers and, by extension, poor choices. The unnamed source forthrightly acknowledged that CalPERS was underserved relative to equity market returns. This source goes on to suggest that hedge funds may need to bring fee structures in line with results.

A Third View

Hedge funds, by definition, are designed to function as preservers of wealth, while taking full advantage of investment opportunities that do not subvert that objective. The hedge fund industry would be better served by emphasizing the tremendous success it has enjoyed in this traditional role.

Hedge funds cannot, nor should they attempt to, be all things to all clients. Concerns regarding fee structure, complexity, and scalability need to be addressed with potential clients up front. Net performance is, and will continue to be, the best measure of hedge fund success.

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