This suprises me, I would think the allocation to most alternative categories would be increasing these days, especially to market neutral hedge funds, fixed income strategies and managed futures. I have to believe that they are doing this because their funds have underperformed over the last 5 years, even though they say its due to high fees. I hope a sophisticated investor like this isn’t actually using the equity markets as a benchmark. This is unfortunate, it seems like they’re doing this at the wrong time. I wonder where all this cash will be directed to?
That is a valid observation but if I have to guess, you don’t work in a pension plan. The Board/Trustees are normally not investment professionals so your investment strategy is as good as their investment knowledge. In this stakeholder relationship, communication is the key. This does not mean BS your way through, it means to “take them on the journey”. Hedge fund, unfortunately, is one of the journey that most board member don’t want to join you. You may be surprise to find that PE is much easier.
If you read their annual investment report as at Jun-13. The fund returned 13.2%, 135bps above the benchmark. The question is then what benchmark do they prescribe to hedge funds. If I had to guess, I’ll say equity or 0.5 beta benchmark which will still kill most hedge funds in a heart beat.
I recall reading that the long term performance of the hedge fund portfolio was 4.5% or something like that. Anyway, I’m sure the decision is partly based on performance metric, and partly based on PR policy as well. All else equal, I can see why a public investment program in California would be adverse to paying high fees to some hedge fund managers. Public entities in California have made less logical decisions, like when the city of LA took a $5 million loss or something like that because they just did not want to do business with Goldman Sachs, because hippies and such.
Goldman Sachs is full of hippies?
Hippies are more a Northern California phenomenon than an LA one.
I think that was Oakland. Nonetheless, point made!
The fee’s argument is strange, it’s kind of like deciding to stop buying iPhones because Apple takes too much margin.
My only comment would be that, 8 years into my career, I am much more convinced of the existence and strength of the business cycle and this appears to be just another of many examples of the psychology that underlies it.
Stevens, can you elaborate on the psychology aspect? Also, where do you see us in the business cycle today?
To me it looks like calpers is behaving like an investor who trades off of their gut feelings. I can picture them saying “equity markets have outperformed for 5 years in a row, why weren’t we in stocks? Lets dump these hedge fund things so we can earn a higher rate of return”. Retail investors flock to equity markets only after a major run up in equities, and this seems to be the same mentality.
If they are unhappy with the performance after fees, maybe they are in the wrong hedge fund strategies, or maybe they don’t understand what they’ve invested in. If I’m running a large pension fund, I’m slowly increasing my allocation to alternative categories every day that the equity markets make new highs. They have a large allocation to private equity but I think they should be moving to alternative credit strategies, managed futures and market neutral funds. Asset classes are returning to more normalized levels of correlation, which should benefit these types of investments the most.
I think the problem is that CalPERS has to report to politicians who have limited knowledge of finance, and perhaps must respond to constituents who know even less…
2013, the S&P rocketed up 30% while most hedge funds were flat or mildly positive. Presumably CalPERS investment professionals know that the business cycle has up years and down years, and that a diversified asset adds value to a portfolio allocation but also by definition should not be up hugely when equity markets are up. But these guys have to report to people who don’t necessarily understand that.
Or there was a calculation of returns after fees that didn’t look so great. But CalPERS should be large enough to negotiate stiff fee reductions.
I think you summed up my feelings pretty well yourself, but I will try to elaborate.
Basically the press release seems to me a thinly veiled excuse for their decision. In reality, if an investor is adequately compensated in terms of their net returns, then complexity and management fees don’t seem to justify withdrawing from an asset class. Calpers already have a team in place and since they started allocating I don’t believe that Hedge Funds have become more complex. With respect to fees, many manager’s fees have actually compressed over the past few years.
Therefore I would guess that the decision has more to do with the change in CIO and recent performance of HFs vs long only strategies. This is the type of psychology I am talking about and I see it everywhere, investors piling back into structured credit (e.g. CLOs), long only equities, subprime credit, IPOs etc and pulling out of diversifying strategies such as managed futures and global macro.
I may be wrong but the global financial machinery seems pretty similar to me than it has been in the past, e.g. central banks trying to manage growth and inflation (albeit through the use of QE), fractional reserve banking etc. We are clearly in a period of an expantionary monetary policy and an associated expansionary credit cycle and so I can’t see any obvious reasons why it will have a different ending this time around. I don’t get paid to forecast, but my guess would be that we are closer to the end than the beginning. I wouldn’t be cutting all of my “risk assets”, but like you I would be trimming these on the margin as they perform and allocating to assets which hopefully provide more downside protection.
Unfortunately, or perhaps fortunately for us, the herd takes the opposite approach.
Calpers does indeed seem to have a very naive investment policy - presumably due to political interference. I know more about the private equity side and if you look at their track record its pretty horrible. They deployed as much capital in the three years from 2005 to 2007 as in the twenty years before that. Then in 2009/10 their commitments fell off a cliff.
At worst, a rational long-term investor should make consistent commitment amounts each year. If you want to be savvy about it, you should try to increase your allocation following a market crash. To scale back your commitments by about 90% as they did in 2009 suggests that the investment committee decisions are not being made solely on the basis of sound investment advice. Instead, I would guess they are being driven by emotionally and politically charged biases that would make the average punter off the street blush.
The statement on pulling out of HF lacks detail, but their is no sense that net returns were considered, let alone portfolio diversification benefits, sharpe ratios etc. The logic seems to have been that they have underperformed public equities recently and have high fees so sell them all.
Calpers is big dumb money. There are some long tenured senior people there who are legendary for falling asleep during investor pitch meetings. It’s just a big herding behavior type of firm, let’s chase the hot strategy of the moment and allocate as much as possible at the top, blah blah. Too big for their own good.
I heard the same thing.
CalPERS’ entire modern investment credibility comes from Mark Anson, who left the group years ago. Anyone who currently speaks about CalPERS’ awesome investment decision-making is either living in the past when Anson was at the CIO helm or is confusing a plan’s size given the contributor base with investment skill.
I think it’s highly unlikely they actually exit. Considering the amount of capital invested and the time it takes to unwind these positions, the sentiments will change a dozen times by then.