New York: At quick glance, public pensions should be running from hedge funds.
The secretive investment firms famous for their market-beating returns — and high fees to match — have recently produced losses or meagre profits far below expectations. And thanks to a steady stream of bad publicity, public perception of the industry may be at an all-time low. At least one recent estimate found that clients are pulling money at a rate not seen since the financial crisis, according to research firm HFR’s tally of industry flows.
Recent moves by a few large institutional investors were seen as the beginning of a mass exodus. In 2014, the $300 billion (Dh1.1 trillion) California Public Employees’ Retirement System said it was getting out of most hedge funds. Then, this February, the $15 billion Illinois State Board of Investment said it would reduce its target allocation from 10 per cent to just 3 per cent.
In April, the $51 billion New York City Employees Retirement System (NYCERS) decided to exit hedge funds entirely.
Henry Garrido, a worker union leader and NYCERS trustee, cited the industry’s high fees and poor performance in scoring a near-unanimous vote in favour of his proposal to axe about $1.4 billion from hedge funds including Brevan Howard and D.E. Shaw Group, about 3 per cent of its portfolio.
“I think it’s insane,” Garrido said in a pension trustee meeting this year, “that we keep pouring money into hedge funds.” Data, however, suggest that US public pensions are staying put. The number of public pensions that use hedge funds has steadily increased to 282 in 2016 from 234 in 2010, data from research firm Preqin show. The average percentage of pension portfolios in hedge funds has also rose to nearly 10 per cent.
High fees, low returns
Steve Yoakum, executive director of the State School & Education Employee Retirement Systems of Missouri, said his pensions are sticking with hedge funds despite concerns about high fees and low returns.
“We are parking our money there because we don’t like the alternatives,” Yoakum told Reuters, adding “They are doing what they were hired to do.” Approximately 12 per cent of the systems’ $38 billion is invested with hedge funds, including those managed by AQR Capital Management, Renaissance Technologies, Pershing Square Capital Management, Och-Ziff Capital Management and Bridgewater Associates.
Indeed, most institutional investors do not look to hedge funds primarily for outsize returns. A 2014 Preqin survey found the most important factor were returns uncorrelated to stock markets, followed by gains regardless of market direction, and lowering portfolio volatility, among others. Just 7 per cent said high returns were an objective, according to Preqin.
Teachers in Missouri are not the only ones sticking with hedge funds. Recent surveys by Deutsche Bank, Preqin and BlackRock show that the majority of pensions and other institutional investors were keeping or increasing their hedge fund allocations.
Large public pensions planning or considering an increase to their hedge fund allocation are the California State Teachers Retirement System, and the general state pensions of Massachusetts and North Carolina. At least six pensions are considering an investment in hedge funds for the first time, according to Preqin, including the Chicago Firemen’s Annuity & Benefit Fund, Louisiana School Employees’ Retirement System, Iowa Public Employees’ Retirement System and the San Francisco Employees’ Retirement System. None of the them responded to questions seeking comment.
Frustration and hard bargains
Pensions may be standing by hedge funds, but they must reckon with increased frustration.
Public perception may be at a low point. Hedge fund managers seem to be pilloried daily by politicians and plutocrats, including Democratic presidential candidate Hillary Clinton and billionaire Warren Buffett. Organised labour has also been highly critical of hedge funds; a coalition of New York state unions are the major backers of the “Hedge Clippers,” a protest group launched in early 2015. A popular US television series, Showtime’s Billions, also plays on the industry’s negative stereotypes, including risky investing, insider trading and conspicuous consumption.
Joanne Fonseca, a retired state schoolteacher in Rhode Island whose pension invested in Luxor Capital Group and Och-Ziff, tapped into a growing sense of anger.
