Monday, October 13, 2014

The Unlikeliest Argument Against Hedge Funds

The Unlikeliest Argument Against Hedge Funds

Three weeks ago the State Employees Association of North Carolina (SEANC) called upon Treasurer Cowell to follow CalPERS’ lead in eliminating its hedge fund exposure.  SEANC argued that CalPER’s decision to eliminate hedge funds might lead to a “run on the bank” in which institutional investors rush to the exits.  According to SEANC, North Carolina’s pension could be damaged if it doesn’t get ahead of these sales.  SEANC’s thesis is so far-fetched that I didn’t think it was worth commenting on until an email from their consultant, Benchmark Financial, showed up in my inbox last week.  The email endorsed SEANC’s contention.

As a forensic investigator, Benchmark should have corrected SEANC’s contention, rather than repeating it.  First, CalPERS isn’t eliminating its exposure to hedge funds.  Rather it is shutting down its absolute return strategies, which is a specific $4 billion program.  Second, North Carolina had already eliminated most of its exposure to absolute return strategies over the past four years.   In other words, CalPERS is following North Carolina, not the other way around.  Third, very little is certain in the world of investments, but there’s a zero percent chance of a “run on the bank” as a result of CalPER’s decision.  Even if institutional investors followed CalPERS’ decision and dumped their hedge funds, it wouldn’t have the dire consequences envisioned by SEANC and endorsed by Benchmark.

Hedge funds aren’t an asset class.   Rather they are private funds that invest in wide array of equity, fixed income, commodities, and other strategies.  While some specific strategies could sustain losses if there was a mass redemption, many hedge fund strategies can easily be liquidated.  As a result, hedge funds can absorb all sorts of redemptions without leading to a “run on the bank.”

SEANC’s press release and Benchmark’s endorsement is worrisome because they create unwarranted worry among state employees and retirees.  Obviously, investing involves a variety of risks, and participants ought to be familiar with them.  However, it’s irresponsible to create risks that don’t exist. 

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