Wednesday, September 17, 2014

CalPERS Throws in the Towel on Hedge Funds

In organizing the posts on this blog, I've favored the label "alternative investments," as opposed to, for example, just "hedge funds."  In the past, we've written one of the most widely read posts about the public's "Two Faces on Private Equity." Rereading this, it is ironic that Warren Buffett, a vociferous critic in print at the time, has now thrown in with Brazilian private equity partners 3G on major investments.

The Yale endowment fund, led by Dave Swensen, has been one of the institutional models for successfully using alternative investments, including hedge funds, private equity, and real estate. Harvard's endowment has been in the news recently because of its falling down repeatedly in its once legendary investment management.  This post makes good background reading for today's issues about CalPERS.

CalPERS has assets of $298 billion in its investment portfolio to support 1.6 million members, either currently working or retired,or a stunning $186k per member, most of whom are working so the retirees should be quite comfortable.  The trouble is that for all their shareholder activism, self-promotion, and expensive internal management, CalPERS cannot select, construct and manage an alternative investment portfolio, in this case specifically hedge funds.

According to the Wall Street Journal, the fund's fiscal year-ended June showed its hedge fund portfolio of $4 billion returning 7.1% versus Vanguard's Balanced Index return of 12.5%.  The prior year too showed dramatic under performance at 7.4% versus 10.8% for Vanguard's Balanced Index.

The Journal notes that HFR's index of 2,000 hedge funds has been under performing its benchmark since 2009.  It points out that even in the down year of 2008 hedge funds lost 19%, not much less than traditional equity investors who lost 22.2%.  So, the $24 trillion hedge fund industry doesn't protect the downside in any significant way.

However, just to note that I got an interesting post from AQR's Cliff Asness which raises a very interesting point on which he has hammered for a while. To paraphrase, much of the institutional investor's market-like performance for hedge funds comes from the fact that their positions, whether in outside funds or in funds-of-funds, have too much of a net long position and therefore shouldn't be expected to perform too differently from traditional longs, like balanced funds. CalPERS and Harvard and others suffer from this disease of not being short enough in their hedge funds.

Proponents of hedge funds claim that there are good managers out there who can point to long-term out performance.  Who are they?  What's the basis for this claim?  What are the strategies and processes in this opaque world that can produce this alleged out performance?

Even Morningstar rates hedge funds for individuals.  If CapPERS concludes that hedge funds are too complex to manage, produce little diversification benefit, are too expensive and not scalable at their asset level, how can a small investor ever hope to benefit from these investments.  You can guess my answer.

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