Tuesday, September 16, 2014

CalPERS Withdraws From Hedge Funds: The Reaction

CalPERS Withdraws From Hedge Funds: The Reaction

After deliberating for the last several months, CalPERS is eliminating its exposure to hedge funds.  The divestiture involves $4 billion or only 1.5% of the pension’s assets.  In explaining, CalPERS decision, Ted Eliapolis, the interim CIO, captured my view of hedge funds in large institutional portfolios:

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 CalPERS size, the hedge fund program doesn’t merit a continued role.

Because CalPERS is so large ($300 billion in assets), their decision is attracting a great deal of attention.  However, we have to keep in mind that CalPERS never made a huge commitment to hedge fund strategies in the first place.  In other words, this is not the case of the hedge fund industry’s biggest advocate losing faith.  Throughout the past decade, CalPERS has been a relatively cautious participant.  They’ve invested in a group of hedge fund-of-funds and directly with a series of hedge fund managers, and the program hasn’t delivered.
Hedge Fund Due Diligence (1999)
Michael Corkery and Alexandra Stevenson of The New York Times captured two priceless and rather inane reactions to CalPERS decision.[1]  After expressing shock, Charles Gradante managing principal of the hedge fund advisory firm Hennessee Group said:

Hedge funds are the place to be now because people are expecting a major correction. You’re looking at a very bumpy stock market over the next five years and that is where hedge funds will prove their mettle.

First, it’s hard to be shocked since CalPERS had announced earlier in the year that it was reconsidering its hedge fund program.  Second, Mr. Gradante’s comment about the looming correction is the kind of reaction you’d expect from an unscrupulous retail stock broker, not an institutional advisor.  While we may, indeed, suffer a correction at some point, and certain hedge funds will undoubtedly outperform stocks, there is a far less expensive and effective way for investors to protect against Mr. Gradante’s forecast.  Hold more cash.  Third, Mr. Gradante’s comment reveals a common misunderstanding about large institutional portfolios.  While a small investor might be able to dodge the worst effects of a market correction, it is impossible for a large pension to adopt the needed tactical strategies.  Most investors, especially large ones, are best served by adopting a sensible long-term investment strategy that enables them to ride through the inevitable bumps.

Anthony Scaramucci, founder of SkyBridge Capital, provided The New York Times with a more telling reaction when he said, “It’s an admission by Calpers that they don’t have the right staff or the right managers.”  I suppose Mr. Scarmucci’s feels a bit threatened, since his business model is predicated on getting investors to accept the complexity and high costs of building portfolios of hedge fund managers.  As a major player in hedge fund-of-funds, I would have expected Mr. Scaramucci to have a more nuanced response.

While I’m sure that SkyBridge has retained some of the finest hedge fund managers in the world, its road to success has been built on savvy marketing.  There’s no greater example of SkyBridge’s marketing prowess than the SALT Conference.   The Conference is an annual gathering in Las Vegas featuring over-the-top parties and celebrity speakers wooed by huge speaker’s fees and the chance to rub elbows with Wall Street’s elite.  I’m not sure how President Bill Clinton, President George W. Bush, Prime Minister Tony Blair, Wolfgang Puck, Al Pacino or Oliver Stone can help investors build hedge portfolios, but they’ve been featured speakers at the SkyBridge conclave.

CalPERS has come to an entirely sensible decision about its hedge fund program.  Regrettably I don’t think it’s going to put much of a dent in the hedge fund marketing machine, which is continuing to draw in more and more assets.

[1] http://dealbook.nytimes.com/2014/09/15/nations-biggest-pension-fund-to-end-hedge-fund-investments/?ref=business

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