CalPERS Dumps Hedge Funds: High Fees & Lousy Returns

California Public Employees’ Retirement System, known as CalPERS, announced recently that it is terminating all of its investments in hedge funds after the conviction of their former CEO, Federico R. Buenrostro Jr., for hundreds of millions in fraud involving the funds. 

Hedge fund management has, in the past, been highly lucrative, because the typical hedge fund charges a very high 2% management fee for assets invested, and then takes a 20% chunk of all profits the fund produces. 

Although many hedge funds promise high investment returns, most have underperformed market indices. Yet after vacuuming up $150 billion of pension assets, CalPERS’ dumping could signal the beginning of a mass hedge fund exit.     

Pension assets of America’s largest 200 defined-benefit plans directly invested in single- and multi-strategy hedge funds leapt 15.1% to $115 billion last year, up from $100 billion the year before. Adding in $35 billion of hedge-funds-of-funds investments, that meant hedge funds commanded $150 billion in pension cash. 

Preqin Alternative Asset Analysts recently reviewed the degree of hedge-funds controlling public plan cash. With government dominating the vast majority of defined-benefit pension funds, Preqin reported, 22% of institutional capital invested in hedge funds came from public pension plans.  About 44% of hedge-funds received some public cash, and 34% added public money to hedge funds in the first six months of 2014. 

Public pension plans have been investing in hedge funds for decades, but over the last five years the number of public pension plans investing in hedge funds grew 15%, from 234 to 270 plans. The percent of assets of public fund assets invested in hedge-funds also jumped by 20%, from 7.2% to 8.4%.      

Although hedge funds only average control of about one out of every twelve dollars in public funds, the Texas County and District Retirement System has 24.6%, and the Maryland Retirement and Pension System has 17%, of their total assets in hedge funds.   

Amy Benstead, Head of Hedge Fund Products for Prequin, commented:

With CalPERS joining the ranks of a handful of other high profile US pension schemes cutting back on hedge-funds, there could be concerns that these public retirement systems are losing faith in the asset class as a collective. For now at least, this does not seem to be the case, and in fact, there are more US public pension funds than ever before allocating capital to hedge-funds, and these investors are investing the most they ever have in the asset class.

CalPERS paid $135 million in hedge fund fees in the fiscal year that ended June 30 for hedge fund investments that earned +7.1%. But in a terrific year for investors, CalPERS earned +18.4% from its other investments, and paid a fraction of the fees. 

Once, CalPERS, as an international leader in public sector investments, led public pension plans to embrace hedge fund investing fully. Yet after suffering high fees, lousy returns, and fraud, many of those same plans will follow CalPERS in dumping hedge funds.