Key Takeaways
- • CalPERS, the largest U.S. pension fund, announced the complete exit of its $4 billion hedge fund program comprising 24 hedge funds and six hedge fund-of-funds, citing prohibitively high fees that cannot be justified against returns.
- • The pension fund paid $135 million in hedge fund fees for the fiscal year ending June 30, 2014—up from $115 million the prior year—prompting interim Chief Investment Officer Ted Eliopoulos to declare that "cost matters" and that hedge funds represent "an expensive investment vehicle, especially at our scale."
- • CalPERS' hedge fund portfolio has delivered below-benchmark returns, failing to outperform the HFRI (hedge fund research index) over the past several years, though management characterized the exit decision as primarily cost-driven rather than performance-driven.
- • The move carries significant symbolic weight given CalPERS' pioneering role as one of the first pension funds to enter hedge fund investing in 2002, potentially signaling broader institutional disenchantment with the asset class despite $57 billion in industry inflows during the first half of 2014.
- • The decision represents a strategic pivot toward portfolio simplification and cost reduction, even as the broader hedge fund industry continues to attract institutional capital based on perceived risk mitigation and drawdown protection benefits.
Summary
California Public Employees' Retirement System announced last week that it will liquidate its entire $4 billion hedge fund allocation across 24 separate hedge funds and six hedge fund-of-funds. The decision marks a watershed moment for the pension fund industry, given CalPERS' historical significance as one of the earliest institutional adopters of hedge fund strategies, having entered the asset class in 2002. The exit underscores growing pressure on alternative asset managers to justify fees in an environment where large institutional investors possess sufficient scale to demand more cost-efficient solutions.
The primary impetus behind the decision centers on fee economics rather than tactical performance considerations. CalPERS' interim Chief Investment Officer Ted Eliopoulos stated that "one of our fundamental investment principles is that cost matters," emphasizing that hedge funds function as "an expensive investment vehicle, especially at our scale." The pension fund's fee burden has escalated meaningfully, reaching $135 million in the fiscal year ending June 30, 2014, compared to $115 million the previous year. This 17 percent year-over-year increase in absolute fees crystallized the cost-benefit analysis underlying the divestment decision.
While management framed the announcement as primarily cost-driven, the hedge fund portfolio's lackluster risk-adjusted returns provided supporting justification. CalPERS' hedge fund holdings have failed to outperform the HFRI benchmark index over the past several years, raising questions about whether fee levels were commensurate with value delivered. The combination of rising fee expenses and below-benchmark returns created an untenable investment thesis at the pension fund's scale.
The broader implications of CalPERS' exit remain contested within the institutional investment community. While the decision potentially signals a trend of institutional disenchantment with hedge fund fees and complexity, industry data suggests sustained appetite for alternative strategies. Hedge funds attracted approximately $57 billion in net inflows during the first two quarters of 2014, indicating that many institutional investors continue to view hedge fund exposure as providing meaningful portfolio diversification and drawdown protection benefits. CalPERS' decision may reflect fund-specific management quality issues rather than a sector-wide rejection of hedge fund strategies.
The primary impetus behind the decision centers on fee economics rather than tactical performance considerations. CalPERS' interim Chief Investment Officer Ted Eliopoulos stated that "one of our fundamental investment principles is that cost matters," emphasizing that hedge funds function as "an expensive investment vehicle, especially at our scale." The pension fund's fee burden has escalated meaningfully, reaching $135 million in the fiscal year ending June 30, 2014, compared to $115 million the previous year. This 17 percent year-over-year increase in absolute fees crystallized the cost-benefit analysis underlying the divestment decision.
While management framed the announcement as primarily cost-driven, the hedge fund portfolio's lackluster risk-adjusted returns provided supporting justification. CalPERS' hedge fund holdings have failed to outperform the HFRI benchmark index over the past several years, raising questions about whether fee levels were commensurate with value delivered. The combination of rising fee expenses and below-benchmark returns created an untenable investment thesis at the pension fund's scale.
The broader implications of CalPERS' exit remain contested within the institutional investment community. While the decision potentially signals a trend of institutional disenchantment with hedge fund fees and complexity, industry data suggests sustained appetite for alternative strategies. Hedge funds attracted approximately $57 billion in net inflows during the first two quarters of 2014, indicating that many institutional investors continue to view hedge fund exposure as providing meaningful portfolio diversification and drawdown protection benefits. CalPERS' decision may reflect fund-specific management quality issues rather than a sector-wide rejection of hedge fund strategies.
Go deeper than the headline
Research every firm in this story, track the ones that matter and get the daily briefing — free for 7 days.