`

Skarbeck: Hedge fund track records fail to live up to the hype

October 4, 2014

Ken SkarbeckIn what is being called a watershed moment, the &rdCalifornia Public Employees’ Retirement System announced Sept. 15 that it is dumping its entire hedge fund program. The reason, according to Ted Eliopoulos, the chief investment officer, is “their complexity, cost and lack of ability to scale to CalPERS size.“

Considering CalPERS’ position as one of the largest pension funds on the planet, you can be sure its decision will be discussed in pension board meetings across the world. That CalPERS was the first to mutter what many pension trustees know—that hedge funds have not performed to expectations—is analogous to the tallest person in the crowd shouting, “The Emperor has no clothes!”

Hedge funds became wildly popular with institutions in the wake of the credit crisis, egged on by consulting firms that advise institutions how to allocate portfolios. The original investment premise was that hedge funds, with their unique investment strategies and proclaimed managerial excellence, could provide pensions with a less-volatile investment return that was “non-correlated” to the stock market. That investment skill never materialized and, instead, pensions wound up paying exorbitant fees to underperforming hedge fund managers and their consultants.

For the 10 years ending in 2013, the annualized return of the HFRX Global Hedge Fund Index was 1 percent. The S&P 500 returned 7.4 percent annually and five-year U.S. Treasury notes returned 4.3 percent. The old saw, “You get what you pay for,” doesn’t necessarily apply in investment management. In fact, in the case of most hedge funds, the opposite has been true: “The more you pay, the less you get.”

Incredibly, many pension plans continue to pour money into hedge funds despite their poor returns. The process is enabled by a giant network of Wall Street advisers and consultants steering clients into these vehicles while feasting on the lucrative fees.

The folly is reminiscent of the comment from Citigroup CEO Chuck Prince in 2007 when asked why the bank continued providing risky leverage loans to fund private equity buyouts. Prince replied, “As long as the music is playing, you’ve got to get up and dance. … We’re still dancing.”

Some readers may ask, “Why does pension fund performance affect me?” Well, considering that taxpayers are on the hook for massive annual contributions to public pension plans, the better a pension fund’s investment performance, the less taxpayer money needed to fund the liabilities owed to public employees. For example, last year, Indiana taxpayers contributed $2.1 billion to the state’s public pension plan.

Rating agency Moody’s recently completed a review of the top 25 U.S. public pensions, holding 40 percent of all pension assets, and found them $2 trillion in the hole. Decades of inadequate contributions and overly generous retirement benefits were as much to blame as investment performance for the funding chasm.

As pension liabilities grow, they crowd out spending for services, roads and schools. So, yes, it will be interesting to see what impact CalPERS’ decision has on pension fund allocations to underperforming hedge funds.•

__________

Skarbeck is managing partner of Indianapolis-based Aldebaran Capital LLC, a money-management firm. His column appears every other week. Views expressed are his own. He can be reached at 818-7827 or ken@aldebarancapital.com.

ADVERTISEMENT

Recent Articles by Ken Skarbeck

Comments powered by Disqus