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Pensions Slash Hedge Fund Allocations After Decade Of Subpar Returns

Wednesday, November 16, 2016 4:47
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After a 15-year love affair with hedge funds, pensions and endowments are finally growing weary of their excessive fees, lackluster returns and manager arrogance.  Pensions led a huge rotation into hedge funds in the early 2000’s as investment managers sought higher returns to repair their massively underfunded balance sheets.  That said, after a 15-year trial run, these managers are finally waking up to the fact that they could recreate the performance of most hedge funds with a couple of index positions and simply pocket the “2% & 20%” fees they would have otherwise paid.  As Bloomberg notes, pensions pulled a record $28 billion from hedge funds in 3Q 2016, the most since 2009. 

Unhappy with mediocre results and high fees, pensions in states like Illinois, New York and Rhode Island are slashing their allocations to hedge funds. More than one in four endowments and foundations, from colleges to museums to hospitals, are doing the same or considering it, according to a survey by consultant NEPC. Many are demanding lower fees and better terms to stick around, and usually getting it.

Disappointing returns were certainly a factor. But another reason was the public’s perception of hedge funds as highly risky and run by guys with penthouses and yachts, said David Peden, chief investment officer for Kentucky’s $16 billion portfolio. That was poison at a time when taxpayers were being asked to fork over more to close a 60 percent gap in pension liabilities.

All told, redemptions hit a 2016 peak in the third quarter when investors pulled a net $28 billion from hedge funds, the most since early 2009, according to Hedge Fund Research Inc.

The backlash is part of a broader rebellion that has seen an avalanche of money move from actively-managed funds to low-cost passive products like index funds. The $3 trillion hedge fund industry, however, has become the poster child for the sins of active management because it charges among the highest fees even as performance lags. That doesn’t sit well in the political world of public pensions and endowments. They face pressure to boost returns as an aging workforce enters retirement and tuitions rise.

Honestly, we agree with most everything above but not sure why pension funds would be worried about hedge fund excesses…you throw one little party, with a 1,000 of your closest friends, and everyone freaks out.


Of course, below market returns have hurt the cause of the hedgies.  New York state’s retirement system superintendent estimates that bad performance and excessive fees of hedge fund investments have cost NY pensioners $3.8 billion over the past 8 years.

“Hedge fund managers continue to reap hundreds of millions of dollars in fees, regardless of their performance, which is a rip-off at the expense of pensioners,” said Maria T. Vullo, who as superintendent of the New York Department of Financial Services is the state’s top financial regulator. She has estimated hedge funds cost her state’s retirement system $3.8 billion in fees and foregone returns over the last eight years.

Yet on average hedge funds have failed to outperform stocks since 2008, returning only 3.6 percent a year, while traditionally commanding fees of 2 percent of assets and 20 percent or more of the fund’s annual profit.

Citing high costs and complexity, the California Public Employees’ Retirement System, the largest U.S. pension fund, kicked off the exodus two years ago, when it voted to shed its $4 billion hedge fund stake.

Meanwhile, pensions and endowments from all over the country are slashing allocations.

Momentum picked up this year as performance continued to lag. The $16.1 billion Illinois State Board of Investment said last month that it has moved two-thirds of its assets to passive management and away from the “honey pot” of high fees, said Chairman Marc Levine.

In coming months, Rhode Island’s $7.7 billion pension fund is redeeming an estimated $585 million from hedge funds — including Och-Ziff Capital Management Group LLC and Brevan Howard Asset Management — and reallocating it to low-fee index funds.

Among colleges, Berea College is unwinding about $42 million in hedge fund commitments this year from its $1.1 billion endowment. For the year ended June 30, the endowment’s hedge fund allocation lost 2.5 percent, which didn’t help the school’s overall investment decline of 1.1 percent.

“The performance net of fees wasn’t paying off,” said Jeff Amburgey, vice president for finance for the private college in Kentucky, which doesn’t charge tuition.

Hedge Funds

Of course, some funds, including William Ackman’s Pershing Square, have attempted to limit the redemptions by lowering fees.  That said, we suspect the cuts are a bit too little too late.

Firms from Brevan Howard to Caxton Associates and Tudor Investment Corp. have trimmed fees amid lackluster performance.

William Ackman’s Pershing Square Capital Management last month offered a new fee option that includes a performance hurdle: It keeps 30 percent of returns but only if it gains at least 5 percent, according to a person familiar with the matter.

The offer came after Pershing Square’s worst annual performance, a net loss of 20.5 percent in 2015. Pershing Square spokesman Fran McGill declined to comment.

“They had a terrible year and they have to be extremely worried about a loss of assets under management,” said Tom Byrne, chairman of the New Jersey State Investment Council, which had about $200 million with Pershing Square as of July 31. “You’re losing clients because your prices are too high? Lower your price. That’s capitalism.”

Well, it was a good run but you can’t charge “2% & 20%” while underperforming all the major indices forever.


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