Friday, May 23, 2014

Creating a Muddle: San Francisco Contemplates Hedge Funds

Creating a Muddle:  San Francisco Contemplates Hedge Funds

The Chief Investment Officer for the San Francisco City & County Employees' Retirement Systems, with $20 billion in assets, has proposed a new 15% allocation to hedge funds and a 12% allocation to alternative equity allocations.[1]  The allocation to alternative equity allocations would include a disparate collection of activist managers, country specialists, sector specialists and long-short managers, according to William Coker, San Francisco’s CIO.  In other words, it’s a broad classification of hedge funds that utilize equities in some capacity.  Even as the nation’s biggest public pension plan, CalPERS, scales back, the alternative bubble continues to inflate.

The foray into hedge funds will turn San Francisco’s asset allocation into a muddle.  Traditionally, there has been a clear distinction between equity (public stocks, private equity), debt, and real estate.  As I’ve written repeatedly, hedge funds aren’t an asset class.  Rather they are strategies that can encompass any or all of the traditional asset classes.  As a result, San Francisco isn’t going to have a very precise picture of the risks that it is taking.

Fortunately, some of San Francisco’s trustees are skeptical.  One even wrote Warren Buffet a letter, and Mr. Buffet counseled him to avoid hedge funds altogether.  Pensions & Investments reported a bit of Mr. Coker’s response to the trustees:

Mr. Coaker insisted that the pension fund would assemble a top-grade hedge fund staff and a top hedge fund consultant, and would do extensive due diligence to ensure that only top-grade hedge funds with strong return potential would be hired.

“We need to be very selective,” he said.

I hope that this wasn’t his best argument for making the changes to the allocation, because the rationale is laughable.  Who isn’t going to try to assemble a top-grade staff and top hedge fund consultant?  Who isn’t going to promise extensive due diligence?  Who wouldn’t want to hire top-grade hedge funds and insist on strong return potential?  As the umpteenth public fund to invest in hedge funds, there’s little hope of San Francisco meeting any of these thresholds.  Mr. Coaker can promise his trustees that he’ll be extremely selective, but it’s unlikely the better hedge fund managers will allow San Francisco the luxury of selectivity.

It’s hard to resist the lure of hedge funds.  I’m hoping San Francisco can.


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