Last month, CalPERS, the largest public pension fund in the U.S., made the decision to eliminate hedge funds from its portfolio. “We are always examining the portfolio to ensure that we are efficiently and cost-effectively achieving our risk-adjusted return goals,” said Ted Eliopoulos, CalPERS Chief Investment Officer, in a press release on September 15. “Hedge funds are certainly a viable strategy for some, but at the end of the day, when judged against their complexity, cost, and the lack of ability to scale at CalPERS’ size, the ARS program is no longer warranted.”
Despite explicitly stating that performance was not a factor, the CalPERS decision caused a media frenzy in the immediate aftermath. While we at Balentine agree with legitimate skepticism about the hedge fund industry, we disagree with those who used the CalPERS announcement to jump on the bandwagon to dismiss the value of hedge fund investing entirely. Indeed, on Wednesday, September 24, Eliopoulos took to CNBC’s “Closing Bell” to clarify this decision. Noting that even though the actual amount eliminated was $4 billion, it only represented just over 1% of the total $300 billion portfolio, Eliopoulos said, “For us, in making our hedge fund decision, we looked at the relatively small scale of the hedge fund program and its real inability to have a meaningful impact on our total portfolio.”
Eliopoulos also stated, “We also looked at the cost and complexity of the hedge fund program and decided that it just was not practical or beneficial for us to scale up the portfolio to a size that would be meaningful to our portfolio.”
In our view, the key points that Eliopoulos made were that there are two important ingredients to pay attention to in order to be successful in allocating to hedge funds in a portfolio: terms and access. When investing in hedge funds, we demand very specific terms to alleviate many of the traditional criticisms of hedge funds, specifically surrounding transparency, fees and liquidity.
- One of the biggest complaints about hedge funds is the lack of opacity and the inability to view underlying securities. Balentine’s customized hedge fund solution allows our Investment Strategy Team to view underlying securities at any time on a near real-time basis.
- The standard fee structure for hedge funds is “2 and 20,” meaning hedge funds will charge 2 percent of all assets managed and an additional 20% of any profits earned. We are always looking to improve upon those terms.
- While many hedge funds have multi-year lock-ups, Balentine’s current Manager Skill allocation is structured to have 100% redeemable liquidity on a quarterly basis with 90 days’ notice. This affords us a great deal of flexibility in changing our overall allocation to hedge funds.
Eliopoulos’s second point was about the lack of access. With its large pool of capital, CalPERS was increasingly unable to access the unique hedge funds that would meaningfully improve their overall portfolio performance. This highlights an important but often overlooked point that hedge funds are not an “asset class.” Instead, the hedge fund universe is heterogeneous in nature and comprises a wide range of strategies, which play various roles in portfolios at different times and market conditions. In other words, not all hedge funds are created equally. We diversify exposure across several strategies including global macro, trading, event-driven and relative value. In addition, we believe that oftentimes the most effective managers are found globally and are small to medium in size. In addition, we at Balentine have the ability to scale hedge funds to make it a meaningful part of portfolios. At its extremely large size, CalPERs no longer had this advantage.
It is our hope that in the aftermath of the maelstrom caused by the CalPERs decision, a dialogue emerges about the role hedge funds play and the importance of finding the right strategies and vehicles to help investors reach their goals. At Balentine, we will continue to focus on terms and access to improve the odds of success in hedge funds. Instead of jumping on the bandwagon of getting rid of hedge funds entirely, we are confident that our customized Manager Skill building block will play the role it was designed to play in portfolios: providing protection to strategies while generating returns uncorrelated to stocks and bonds.
Postscript: CalPERS recently made another significant announcement which attracted far less attention. This article describes their decision to make greater use of index funds to implement its portfolio efficiently. For many, the topic of index fund investing is far less interesting and sensational than hedge fund investing, but the points they make in this announcement are just as substantive. Frequent readers of our Market Notebook will know how much we agree with them.