Key Takeaways
- • CalPERS is exiting its entire $4 billion hedge fund program, announced two years prior to July 2016, citing high costs, complexity, and misalignment with its investment principle of taking risk only when expecting proportional reward.
- • CalSTRS is moving in the opposite direction, adopting a "risk mitigation strategy" in November 2015 that allocates 9 percent of its portfolio to long-term U.S. Treasury bonds and hedge funds designed to minimize losses during market downturns.
- • This divergence represents one of the largest strategic separations between the two California public pension funds since CalSTRS assumed independent management of the teacher pension fund in 1982 under separate legislation.
- • CalPERS manages a $301 billion portfolio, while CalSTRS oversees $190 billion—both funds maintain similar investment categories (stocks, bonds, private equity, real estate) but apply differing ratios and ESG screens.
- • The dispute reflects broader industry debate over hedge fund value, with CalPERS emphasizing fee reduction and portfolio efficiency while CalSTRS prioritizes downside protection and portfolio diversification.
Summary
California's two largest public pension systems have adopted sharply divergent approaches to hedge fund investing, illustrating fundamental differences in risk management philosophy and fee tolerance. CalPERS, the nation's largest public pension plan, announced its complete exit from hedge funds approximately two years before mid-2016, liquidating a $4 billion allocation across 24 hedge funds and six hedge fund-of-funds housed within its Absolute Return Strategies program. The decision centered on cost concerns, structural complexity, and CalPERS's core investment tenet that risk should only be assumed when the fund expects to be meaningfully compensated for bearing it.
In contrast, CalSTRS implemented a "risk mitigation strategy" beginning in November 2015 that channels 9 percent of its $190 billion portfolio into long-term U.S. Treasury bonds and hedge fund strategies specifically engineered to reduce portfolio drawdowns during recessions. This allocation choice reflects CalSTRS's emphasis on downside protection and portfolio resilience rather than pure return optimization. The strategic divergence is particularly significant given that both funds are California public pension systems with overlapping beneficiaries and similar asset class frameworks—yet they have reached opposite conclusions about hedge fund utility and cost-benefit tradeoffs.
The two systems' separate governance structures underpin this divergence. CalSTRS gained independent management authority in 1982 when legislation transferred control of the teacher pension fund from CalPERS. Since that split, the systems have grown substantially: CalPERS now manages $301 billion while CalSTRS oversees $190 billion. Both funds employ comparable investment categories—equities, fixed income, private equity, real estate, liquidity, and inflation hedges—but apply different portfolio weightings and apply distinct ESG (environmental, social, and corporate governance) screening criteria. The hedge fund debate adds another layer to this ongoing institutional divergence, reflecting persistent disagreement within the public pension industry over whether hedge fund fees and complexity justify their stated benefits in downturns and portfolio construction.
In contrast, CalSTRS implemented a "risk mitigation strategy" beginning in November 2015 that channels 9 percent of its $190 billion portfolio into long-term U.S. Treasury bonds and hedge fund strategies specifically engineered to reduce portfolio drawdowns during recessions. This allocation choice reflects CalSTRS's emphasis on downside protection and portfolio resilience rather than pure return optimization. The strategic divergence is particularly significant given that both funds are California public pension systems with overlapping beneficiaries and similar asset class frameworks—yet they have reached opposite conclusions about hedge fund utility and cost-benefit tradeoffs.
The two systems' separate governance structures underpin this divergence. CalSTRS gained independent management authority in 1982 when legislation transferred control of the teacher pension fund from CalPERS. Since that split, the systems have grown substantially: CalPERS now manages $301 billion while CalSTRS oversees $190 billion. Both funds employ comparable investment categories—equities, fixed income, private equity, real estate, liquidity, and inflation hedges—but apply different portfolio weightings and apply distinct ESG (environmental, social, and corporate governance) screening criteria. The hedge fund debate adds another layer to this ongoing institutional divergence, reflecting persistent disagreement within the public pension industry over whether hedge fund fees and complexity justify their stated benefits in downturns and portfolio construction.
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