For more than a decade, the California Public Employees’ Retirement System (CalPERS) has invested a modest portion of its plan assets in hedge funds. “Modest” for CalPERS, anyway. As the nation’s largest pension fund, it currently manages nearly $300 billion in assets, approximately $4 billion of which had been allocated to hedge fund investments. The allocation also represents a minuscule drop in the hedge fund market ocean, where investments are measured in the trillions of dollars.
Still, presumably because of CalPERS’ strong reputation among pension plan providers, even small changes in its investment strategy have a way of looming larger than life, in California and nationwide. That’s why we were particularly gratified when CalPERS announced its decision to eliminate all of its hedge fund investments, including 24 hedge funds and six hedge fund-of-funds.
Reducing Costs and Complexity
Whether it’s billions of dollars in a public pension plan or more modest amounts within an individual investor’s portfolio, we have long believed that one’s nest-egg wealth is better invested in solutions that are far more transparent and considerably less costly than what is typically found in the hedge fund industry. CalPERS appears to have reached the same conclusion, when entitling its September 15 press release: “CalPERS Eliminates Hedge Fund Program in Effort to Reduce Complexity and Costs in Investment Portfolio.”
To add insult to injury, even if one is willing to put up with these sorts of hedge fund hassles, there is ample evidence that the extra costs and efforts may well go unrewarded, with returns no better than one could achieve through simpler strategies.
For example, in his article, “Your Lesson from CalPERS’ Dumping of Hedge Funds,” BAM ALLIANCE Director of Investor Advocacy Daniel Solin observed that, “Historically, the performance of hedge funds has been shockingly poor. The annualized returns of the HFRX Global Hedge Fund Index (which attempts to reflect the opportunities in the hedge fund industry) underperformed every major stock asset class, and even three Treasury indexes, for the 10 calendar years from 2004 through 2013.”
Steep expenses may well be among the greatest contributors to hedge funds’ lackluster performances. Typically charging a 2% fee on assets under management plus 20% of any profits, hedge funds start at a distinct disadvantage compared to low-cost funds that are tracking indexes or asset classes, with fees that are fractions of a percent.
There are other factors that likely contribute as well. In his July 2014 commentary on hedge funds, “Enough with the Hedge Fund Hype,” BAM ALLIANCE Director of Research Larry Swedroe commented on the seeming disconnect between hedge fund managers’ profits compared with their typical performance: “The result is one of the more puzzling anomalies in finance—the continued growth of an industry that for a long time has delivered miserable results for investors.”
“Historically, the performance of hedge funds has been shockingly poor.” [Tweet This]
We agree with Daniel Solin’s take-away from CalPERS’ divestiture:
“CalPERS’ wise decision to dump hedge funds should be a wake-up call for you. Your chance of beating the market by stock picking, market timing and mutual fund manager selection is certainly no greater—and probably much less—than that of CalPERS. Instead of engaging in these activities, which are more likely to benefit your broker and active fund manager than you, consider fundamentally changing the way you invest.”
We couldn’t have said that better ourselves.