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 The secretive investment firms famous for their market-beating
returns — and high fees to match — have recently produced losses or
meager 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 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 percent to just 3 percent. 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 favor of his proposal to axe about $1.4
billion from hedge funds including Brevan Howard and D.E. Shaw
Group, about 3 percent 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 U.S. 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 percent.
Steve Yoakum, executive director of the Public 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 percent 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 percent 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.
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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. Organized labor 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 U.S. 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 public school teacher in Rhode Island
whose pension invested in Luxor Capital Group and Och-Ziff, tapped
into a growing sense of anger.
"I am struggling to pay my electric bill while these hedge fund
managers waste fuel riding around in private planes," she said.
Eric Nierenberg, senior investment officer in charge of picking
hedge funds at Massachusetts' $60 billion state pension, said the
fund has been aggressive in pushing for lower fees.
It exited funds of hedge funds, which come with an additional layer
of costs; the move translated into an annual savings of $38.2
million. And its negotiations on fees and getting funds to agree to
custom accounts saves the pension fund $26.5 million a year.
"The fundraising environment has changed and the kind of
conversations you can have with managers are different," Nierenberg
said.
Incentive fees — the amount of investment gains that a hedge fund
manager can take of client gains — fell by an average of 5.3 percent
between the end of 2011 and year-end 2015, according to industry
data tracker HFR.
Others are looking elsewhere. Jonathan Grabel, chief investment
officer of the $14 billion Public Employees Retirement Association
of New Mexico, said the fund was exiting a fund managed by Pershing
Square, among other stock-focused managers, in favor of increasing
allocation to credit and real assets.
Sona Menon, head of North American pensions at investment consultant
Cambridge Associates, said that some retirement systems dissatisfied
with hedge funds had not devoted enough of their assets to them for
a long enough period of time, and then had unfairly compared them to
stock market gains in the recent bull market — just as markets may
be cooling.
"The timing here couldn’t be poorer," Menon said.
Mark McCombe, global head of BlackRock's institutional client
business, said pensions will continue to look to hedge funds to help
them achieve their financial goals.
"These are very individual decisions," McCombe said of the CalPERS
and NYCERS pull outs. "This is not a systemic move away from hedge
funds."
(Editing by Bernard Orr)
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