CalPERS Mulling Steep Cuts to Hedge Fund Investments

At a time when allocations to hedge funds are surging to record levels, one of the largest and widely followed pension funds is contemplating a significant reduction in its allocation to hedge funds.  According to a report by the newspaper Pensions & Investments, The California Public Employees Retirement System, commonly known as CalPERS, is planning to halve its hedge fund allocation. CalPERS, which manages pension and health benefits for more than 1.6 million California public employees, had $5.1 billion invested in hedge funds at the end of March, roughly 2 percent of its $290 billion investment portfolio.

Prolonged Underperformance Leading To Dissatisfaction

The CalPERS decision is influenced by uninspiring hedge fund performance in recent years. A Bloomberg report early this year cited data that showed hedge funds trailed the S&P Index for the fifth straight year in 2013.

In the Pensions & Investments report it was noted that the CalPERS hedge fund portfolio returned 9.2 percent in 2013 – better than its hedge fund benchmark of 5.3 percent. But over a three year period, the hedge fund portfolio underperformed with an annualized 3.3 percent return versus benchmarked return of 5.4 percent.

On a five year scale, its hedge fund investments returned 6.2 percent – barely above the anticipated 5.6 percent return. CalPERS had set an internal benchmark for hedge fund return of 7.3 percent over a 10 year period but its hedge fund program only returned a modest 4.9 percent annualized over the 10 years ending Dec. 31, 2013.

According to the newspaper, CalPERS currently allocates money to a total of 13 hedge funds but plans to terminate allocations to three funds and reduce allocations to the remaining ten. It also plans to make cuts to its hedge funds-of-funds program and reduce the number of fund-of-funds to just two from five.

A Warning for Hedge Funds

As of the moment, there is no mass exodus of public pension funds from hedge funds. In fact the proposed cut by CalPERS is contrary to the trend of higher allocation to hedge funds by the large retirement funds in the US. Early this year, Pensions & Investments had published data from a survey that showed that in the year ended Sept. 30, assets invested in hedge funds by benefit plans grew faster than all other large alternative investment asset class.

Despite recent increased allocation to hedge funds by several large public pension funds, CalPERS’ plan to cut hedge fund allocation is a significant development. It is one of the earliest US public pension funds to invest in hedge funds and its moves are widely followed in the pension funds circle.

Impact on Job Market

CalPERS’ decision to pare down its hedge fund investments by itself likely won’t have an adverse effect on the hedge fund job market in the near-term, considering that the hedge fund industry is still attracting increased allocations from many other public pension funds. However given the influential position of CalPERS among large US pension funds, its decision to chop its hedge fund allocation is sure to attract the attention of other large hedge fund investors and could prompt others also to review their hedge fund allocation policy.

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