Nashville-based hedge fund Rinehart Capital Partners, which specializes in value investing, is closing its operations, lamenting that the current market does not reward funds that employ value investing as a strategy. The seven year old fund was funded, in part, by hedge fund veteran Lee Ainslie who himself is a specialist value investor and who once managed capital at billionaire Julian Robertson’s hedge fund firm. Rinehart Capital founder Andrew Cunagin blamed its poor performance on stimulus driven market conditions and conceded that despite continued backing from Lee Ainslie, the fund was forced to cease operations on redemption pressure from other investors. The fund had been losing money in the last two years and was down again this year as of the end of June.

Value Investors Viewed as Out of Touch

It is not often that a hedge fund manager blames external factors for a fund’s failure but Andrew Cunagin blamed a host of external factors for his inability to generate returns. In his letter to investors, he said the current market is rewarding growth themes over value themes. As opposed to the traditional investment style of buying low and selling high, Cunagin says the strategy that works in this market is one of following momentum and buying high and selling low. The hedge fund manager is critical of high frequency trading and says there is evidence of high frequency traders rigging the price movement of stocks.

Cunagin says his unwillingness to subscribe to the new rules and go against the grain of convention did not find favor with his investors after a sustained period of underperformance. Rinehart was launched in 2007, just months before the pre-crisis peak. It outperformed most funds in 2008, losing only 12 percent during the year, compared to much bigger losses for several hedge funds. It also generated positive returns in each of the years 2009, 2010 and 2011, but struggled thereafter. The hedge fund lost 7 percent in 2012, and followed that up with a 15 percent loss in 2013 and extended its lean period through a further 4 percent loss in the first half of this year.

Some Hedge Funds Struggle

While the overall assets in the hedge fund industry continue to surge, it has not translated into widespread optimism within the industry. The demise of Rinehart Capital is not an exception and there are other funds that continue to struggle in this market.

Hedge fund Emrys Partners,which had assets as high as $200 million, is another example of a fund managed by a once successful manager ,but found the going tough in the current market. The fund was managed by Steve Eisman, who was one of the star managers during the financial crisis. He earned returns of 67 percent in 2007 by shorting the sub-prime mortgage market and for-profit education companies when working at hedge fund FrontPoint Partners. He started Emrys Partners in March 2012 after leaving Frontpoint. His fund reported gains of 3.6 percent in 2012 and 10.8 percent in 2013, significantly lagging the broader market in both years. The hedge fund was also losing money this year.

This year Emrys Partners noted in one of its investor letters that making investment decisions by looking solely at the fundamentals of individual companies is no longer a viable investment philosophy. It closed its operations at the end of June.

A separate report by research firm eVestment found that investors are preferring larger funds over smaller funds. The report found that at the end of 2013, the number of hedge funds with assets in excess of $1 billion increased by 13 percent, while those hedge fund groups with assets between $750 million and $1 billion rose 44 percent. The hedge fund industry growth in assets came from funds with greater than $750 million in assets while reported assets in the universes of funds smaller than $750 million witnessed decline.

Relevance to Job Market

The recent shutdown of hedge funds Rinehart Capital Partners and Emrys Partners may not have much of an impact on the job market given the relatively small size of the two funds. But the concerns about the changed market conditions, as expressed by the two fund managers, are shared by many other hedge fund managers. It will be hard for the job market to see a rebound when many hedge fund managers, especially those managing small funds, are finding it hard to generate acceptable returns for investors.

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Patience is wearing thin among some large public pension funds with regard to their hedge fund investment returns. Years of weak returns combined with high investment fees have forced a few prominent pension funds to consider reducing allocation to hedge funds. Among the pension funds planning cuts in hedge fund allocation include the largest US public pension fund, the California Public Employees’ Retirement System or Calpers, the School Employees Retirement System of Ohio and New Jersey’s State Investment Council. In addition, another pension fund that sought the advice of Warren Buffett on allocating large capital to hedge funds was told in no uncertain terms to choose index funds over hedge funds.

Calpers Mulling 40 Percent Cut

Calpers is a widely followed pension fund as it is the largest pension fund in the US. It had assets of approximately $301 billion at the end of its fiscal year ending June 30. Its return from hedge fund portfolio during the fiscal year was the lowest among all of its asset classes at 7.1 percent, well below the 25 percent return on its public equity investments.

As of June 30, Calpers had $4.5 billion representing 1.5 percent of its portfolio invested in hedge funds. Compared to a few other pension funds, this proportion of hedge fund allocation is quite small. Pension funds such as the School Employees Retirement System of Ohio and New Jersey’s State Investment Council have a much larger proportion of their assets invested in hedge funds. But smaller than anticipated returns on hedge fund investments over the last 10 years is prompting Calpers to consider cutting its hedge fund allocation by 40 percent. Calpers says it will make a formal recommendation to its Board in the fall.

Other pension funds cutting hedge fund allocation are the School Employees Retirement System of Ohio, which will reduce hedge fund investments to 10 percent of its assets in 2015 from its current 15 percent and New Jersey’s State Investment Council which is lowering its hedge fund investment limit to 12 percent from 12.25 percent of its overall portfolio.

Last year, the Los Angeles Fire and Police Pensions fund got out of hedge funds entirely after an annual investment return of only 2 percent over seven years. The fund had approximately 4 percent of its assets, amounting to $500 million, invested in hedge funds but fees paid to hedge fund managers accounted for 17 percent of its total fees.

Buffett Advises Against HF Investments

Another pension fund, the $20 billion San Francisco City & County Employees’ Retirement System is currently debating whether to allocate any capital to hedge funds. Its chief investment officer is making a pitch to allocate as much as 15 percent of the pension fund’s assets to hedge funds. One of the pension fund’s board members had his reservations about the significant hedge fund allocation plan and sought to get the advice of Warren Buffett on the matter. Buffett responded with a hand written note that read, “I would not go with hedge funds — would prefer index funds.”

David Kotok, the chief investment officer at Cumberland Advisors has deep expertise on advising public pension funds on their investments. He says that many pension funds that pump a large portion of their assets to hedge funds are underfunded and are on shaky financial footing.  Kotok adds that such funds are taking on more risks to improve their returns.

Relevance to Job Market

During the recent financial crisis in 2008, many hedge funds reported smaller losses than the overall market and some funds such as Pershing Square Capital Management and Paulson & Co even reported big gains. Such an outperformance during a time of market weakness prompted many pension funds to up their allocation to hedge funds.

But since 2009, hedge funds have consistently, and by a large margin, underperformed the market. As a result, it is not a complete surprise to see some pension funds lowering their hedge fund allocation. Verne Sedlacek, CEO of Commonfund which manages money for pension funds and endowments, says “We are seeing a little moving away from hedge funds, but so far it’s just on the margin.”

Recent data from BarclayHedge and TrimTabs Investment Research shows that hedge funds attracted approximately $83 billion in new capital during the first half of this year, the most since 2007. This suggests that despite concerns from certain investor classes, there is still interest among the broader investor community for hedge funds. And as such this planned pullback by a few pension funds likely will not negatively impact the job market.

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Billionaire Ziff Brothers Shut Down Family Office Hedge Fund

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Survey Claims Hedge Fund Assets to Double by 2018

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