Key Takeaways
- • CalPERS announced termination of its $4 billion Absolute Return Strategies portfolio, exiting 24 hedge funds and six funds-of-hedge-funds, citing high fees, complexity, and inability to scale at the pension fund's $296 billion size.
- • Hedge fund performance significantly underperformed equity markets in 2013: the S&P 500 returned 32.36 percent while the average hedge fund gained just 9.13 percent, yet managers at major firms continued to earn multimillion-dollar management and performance fees.
- • CalPERS's decision does not signal a broad institutional retreat from hedge funds; the move reflects the specific cost-benefit calculation for one mega-cap pension plan rather than a sector-wide rejection by institutional investors.
- • The Texas Teacher Retirement System reduced its hedge fund allocation from 9 percent to 8 percent shortly after CalPERS's announcement, indicating selective reallocation rather than wholesale exodus.
- • CalPERS's 2001 entry into hedge funds had catalyzed peer adoption of absolute-return strategies across U.S. public pensions; the 2014 exit does not reverse that trend for most institutional investors.
Summary
CalPERS, the nation's largest public pension fund with $296 billion in assets under management, announced in September 2014 that it would terminate its $4 billion Absolute Return Strategies portfolio and liquidate positions in 24 hedge funds and six hedge fund-of-funds over the following year. Then-interim Chief Investment Officer Ted Eliopoulos justified the decision on three grounds: excessive fees, operational complexity, and the inability to achieve sufficient scale and diversification within the hedge fund universe given CalPERS's size. "Hedge funds are certainly a viable strategy for some," Eliopoulos stated, "but at the end of the day, when judged against their complexity, cost and the lack of ability to scale at CalPERS's size, the ARS program is no longer warranted."
The decision gained particular resonance amid broader scrutiny of public pension fund investment practices. With many U.S. public pensions significantly underfunded and beneficiaries facing potential benefit cuts, the fees paid to hedge fund managers drew intense criticism. The performance disparity underscored the cost-benefit tension: while the S&P 500 index returned 32.36 percent in 2013, the average hedge fund returned only 9.13 percent according to the HFRI Fund Weighted Composite Index. Meanwhile, senior hedge fund managers at the largest firms continued to command extraordinary compensation; Och-Ziff Capital Management's Dan Och, for instance, earned $400 million in 2013—more than 10,000 times the average California public retiree's annual pension payment.
CalPERS's move was particularly significant because the fund's 2001 decision to enter hedge funds had catalyzed similar allocations across peer public pension systems. However, industry observers cautioned against interpreting the 2014 exit as signaling a wholesale institutional rejection of hedge funds. Two days after CalPERS's announcement, the $126 billion Texas Teacher Retirement System reported a more modest adjustment, reducing its hedge fund allocation from 9 percent to 8 percent—a rebalancing rather than full exit. This selective approach suggested that while mega-cap pension funds like CalPERS might conclude hedge funds no longer justified their costs and complexity, the broader institutional investment community would continue evaluating absolute-return strategies on fund-specific metrics.
The decision gained particular resonance amid broader scrutiny of public pension fund investment practices. With many U.S. public pensions significantly underfunded and beneficiaries facing potential benefit cuts, the fees paid to hedge fund managers drew intense criticism. The performance disparity underscored the cost-benefit tension: while the S&P 500 index returned 32.36 percent in 2013, the average hedge fund returned only 9.13 percent according to the HFRI Fund Weighted Composite Index. Meanwhile, senior hedge fund managers at the largest firms continued to command extraordinary compensation; Och-Ziff Capital Management's Dan Och, for instance, earned $400 million in 2013—more than 10,000 times the average California public retiree's annual pension payment.
CalPERS's move was particularly significant because the fund's 2001 decision to enter hedge funds had catalyzed similar allocations across peer public pension systems. However, industry observers cautioned against interpreting the 2014 exit as signaling a wholesale institutional rejection of hedge funds. Two days after CalPERS's announcement, the $126 billion Texas Teacher Retirement System reported a more modest adjustment, reducing its hedge fund allocation from 9 percent to 8 percent—a rebalancing rather than full exit. This selective approach suggested that while mega-cap pension funds like CalPERS might conclude hedge funds no longer justified their costs and complexity, the broader institutional investment community would continue evaluating absolute-return strategies on fund-specific metrics.
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