Key Takeaways
- • A Roosevelt Institute study on behalf of the American Federation of Teachers found that hedge funds lagged behind overall pension fund performance in approximately three-quarters of years reviewed, costing 11 large public pension funds an estimated $8 billion in lost investment revenue between 2002 and 2015.
- • Hedge fund managers collectively charged $7.1 billion in fees to these same pension funds during the study period, despite delivering underperformance relative to broader portfolio allocations, raising questions about fee-to-performance alignment.
- • Global hedge fund assets under management exceeded $3 trillion as of 2015, despite widespread documentation that the vast majority of hedge funds underperform after fees, while only a small number of elite funds generate alpha.
- • Major institutional investors including pension funds and endowments have reduced or eliminated hedge fund allocations in favor of low-cost index funds, driven by sustained underperformance and concerns about excessive lock-up periods and high fee structures.
- • The performance disparity has prompted institutional investors to reassess the strategic rationale for hedge fund exposure, with some pension funds now operating more like hedge funds themselves through riskier asset allocation strategies.
Summary
A comprehensive study by the Roosevelt Institute, conducted on behalf of the American Federation of Teachers, has intensified scrutiny of pension fund allocations to hedge funds. The analysis examined hedge fund holdings in 11 of the country's largest public pension funds over a 13-year period from 2002 to 2015, using both publicly available data and information provided directly by the pension funds themselves. The findings challenge the conventional investment thesis that hedge funds provide diversification benefits and alpha generation to institutional portfolios.
The study's central conclusion is stark: hedge funds underperformed relative to broader pension fund portfolios in nearly three-quarters of the years reviewed. This persistent underperformance came at substantial cost. The 11 pension funds studied lost an estimated $8 billion in investment revenue due to hedge fund allocations, while simultaneously paying $7.1 billion in aggregate fees to hedge fund managers. This dynamic creates a troubling narrative for institutional investors: subpar returns coupled with premium pricing structures that benefit managers regardless of performance outcomes.
The findings align with broader industry trends documented across multiple institutional investor segments. Endowments and pension funds have increasingly shifted capital away from hedge funds toward cheaper index funds, driven by the recognition that high fees erode returns without corresponding outperformance. A small cohort of elite hedge funds continues to generate market-beating returns after fees, but this represents the exception rather than the norm. Industry data shows that the vast majority of hedge funds fail to justify their fee structures through consistent alpha generation, yet continue to attract capital despite mounting evidence of underperformance.
The timing of this debate reflects shifting market dynamics. Despite documented underperformance, hedge fund industry assets under management surpassed $3 trillion in 2015. However, skepticism among sophisticated institutional investors has grown measurable. Recent withdrawals by major pension funds and endowments signal a structural reassessment of hedge fund allocations. The debate extends beyond simple performance metrics to encompass structural concerns: excessive lock-up periods that constrain liquidity, fee arrangements misaligned with performance, and the opportunity cost of capital that could generate superior risk-adjusted returns through passive or alternative strategies. For institutional investors evaluating hedge fund exposure, the evidence increasingly suggests that the industry's traditional value proposition—outsized returns justifying premium fees—no longer holds for the median fund.
The study's central conclusion is stark: hedge funds underperformed relative to broader pension fund portfolios in nearly three-quarters of the years reviewed. This persistent underperformance came at substantial cost. The 11 pension funds studied lost an estimated $8 billion in investment revenue due to hedge fund allocations, while simultaneously paying $7.1 billion in aggregate fees to hedge fund managers. This dynamic creates a troubling narrative for institutional investors: subpar returns coupled with premium pricing structures that benefit managers regardless of performance outcomes.
The findings align with broader industry trends documented across multiple institutional investor segments. Endowments and pension funds have increasingly shifted capital away from hedge funds toward cheaper index funds, driven by the recognition that high fees erode returns without corresponding outperformance. A small cohort of elite hedge funds continues to generate market-beating returns after fees, but this represents the exception rather than the norm. Industry data shows that the vast majority of hedge funds fail to justify their fee structures through consistent alpha generation, yet continue to attract capital despite mounting evidence of underperformance.
The timing of this debate reflects shifting market dynamics. Despite documented underperformance, hedge fund industry assets under management surpassed $3 trillion in 2015. However, skepticism among sophisticated institutional investors has grown measurable. Recent withdrawals by major pension funds and endowments signal a structural reassessment of hedge fund allocations. The debate extends beyond simple performance metrics to encompass structural concerns: excessive lock-up periods that constrain liquidity, fee arrangements misaligned with performance, and the opportunity cost of capital that could generate superior risk-adjusted returns through passive or alternative strategies. For institutional investors evaluating hedge fund exposure, the evidence increasingly suggests that the industry's traditional value proposition—outsized returns justifying premium fees—no longer holds for the median fund.
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