Key Takeaways
- • CalPERS' $298-billion pension fund eliminated its $4-billion hedge fund program in fall 2020, citing costs, complexity, and the inability of the allocation to meaningfully impact returns relative to plan size, signaling a broader reassessment of hedge fund utility for large institutional investors.
- • Hedge fund strategy effectiveness depends critically on investor expectations and program structure rather than plan size alone; smaller pension plans are actively entering the hedge fund space despite CalPERS' exit, particularly Canadian plans like OMERS and Ontario Teachers' Pension Plan.
- • According to Mercer's Dave McMillan, hedge funds serve primarily as a risk management tool addressing equity and interest rate exposure through non-traditional strategies (long/short, relative value, event-driven) rather than as a standalone asset class, producing differentiated return profiles suited to specific liability matching objectives.
- • Hedge fund adoption remains limited across typical pension plans due to fee structures and perceived complexity, though major Canadian institutional investors have established meaningful allocations, indicating a bifurcated market where sophisticated plan sponsors with adequate scale continue deploying hedge fund capital strategically.
Summary
The CalPERS decision to wind down its $4-billion hedge fund program marked a watershed moment for institutional pension fund hedge fund adoption. The $298-billion California Public Employees' Retirement System eliminated the allocation in fall 2020 after determining that the program, despite its substantial size, could not meaningfully influence returns or risk profiles at the plan's scale. CalPERS interim Chief Investment Officer Ted Eliopoulos attributed the decision to costs and complexity, noting that hedge fund exposure would never "move the needle" for a plan of CalPERS' magnitude. Originally deployed to boost returns, the hedge fund strategy failed to deliver expected performance benefits.
The announcement generated significant client questions across the pension fund industry, particularly among plan sponsors seeking clarity on implications for their own strategies. Dave McMillan, partner and Chief Investment Officer of hedge funds at Mercer, emphasized that the relevant question is not whether plans should invest in hedge funds broadly, but rather how individual plan sponsors define hedge fund utility and structure their programs accordingly. McMillan reframed hedge funds as a specialized risk management tool rather than a discrete asset class, noting that "you can make them what you want" depending on investment objectives—ranging from aggressive return-seeking to conservative risk mitigation.
According to McMillan's analysis, pension plans of all sizes identify equity risk and interest rate risk as their two primary exposures, and hedge fund managers can address these through non-traditional strategies including long/short positioning, relative value trades, and event-driven opportunities. These strategies generate return profiles fundamentally different from traditional equity and fixed income allocations, potentially providing valuable diversification benefits. Major Canadian pension institutions—notably OMERS and the Ontario Teachers' Pension Plan—have already established substantial hedge fund allocations, demonstrating that sophisticated investors with adequate scale continue to see strategic value in the space. Smaller Canadian pension plans are also entering hedge fund investing, though the sector remains constrained by fee structures, perceived complexity, and the perception of added risk that limit hedge fund allocations for most typical pension plans.
The announcement generated significant client questions across the pension fund industry, particularly among plan sponsors seeking clarity on implications for their own strategies. Dave McMillan, partner and Chief Investment Officer of hedge funds at Mercer, emphasized that the relevant question is not whether plans should invest in hedge funds broadly, but rather how individual plan sponsors define hedge fund utility and structure their programs accordingly. McMillan reframed hedge funds as a specialized risk management tool rather than a discrete asset class, noting that "you can make them what you want" depending on investment objectives—ranging from aggressive return-seeking to conservative risk mitigation.
According to McMillan's analysis, pension plans of all sizes identify equity risk and interest rate risk as their two primary exposures, and hedge fund managers can address these through non-traditional strategies including long/short positioning, relative value trades, and event-driven opportunities. These strategies generate return profiles fundamentally different from traditional equity and fixed income allocations, potentially providing valuable diversification benefits. Major Canadian pension institutions—notably OMERS and the Ontario Teachers' Pension Plan—have already established substantial hedge fund allocations, demonstrating that sophisticated investors with adequate scale continue to see strategic value in the space. Smaller Canadian pension plans are also entering hedge fund investing, though the sector remains constrained by fee structures, perceived complexity, and the perception of added risk that limit hedge fund allocations for most typical pension plans.
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