Hedge Fund Capacity May Be Factor in Pension Plan Pullback

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By David B. Brandolph

Sept. 7 — Recent concerns about the costs and lower returns associated with hedge fund investments have driven some of the country’s largest public pension plans to reduce or eliminate investments, but it’s sometimes hedge fund investment restrictions that contribute to plans rethinking these investments.

A number of large public pension plans, including those in California, New York and New Jersey, have reduced or eliminated their hedge fund investments. Other plans are re-evaluating their hedge fund strategies.

Large public plans—those with $100 billion or more to invest—typically have strategies to put 10 percent or more of their portfolio into hedge funds. This would task plan investment managers with finding a profitable hedge fund home for some $10 billion or more. Investment managers for these plans, however, may be having difficulty finding a sufficient array of top-flight hedge fund managers in which to invest this money, Bryan Lewis, chief investment officer for the Pennsylvania State Employees’ Retirement System, told Bloomberg BNA.

That’s because the best hedge funds are more concerned about their performance than in raising investor dollars, Timothy Barron, senior vice president and chief investment officer for the investment advisory firm Segal Rogerscasey in Darien, Conn., told Bloomberg BNA. Sometimes, he said, these funds decide that taking in additional dollars will harm their investment returns. Consequently, they stop taking new money once the fund determines that it has reached its investment capacity, he said.

When this happens, the pool of eligible top-flight hedge funds becomes shallow, making it increasingly difficult for large investors to place all of their hedge fund allocation, Barron said.

Moving Investment Needle Challenging

When the California Public Employees’ Retirement System eliminated its $4 billion hedge fund program in 2014, it attributed the decision to its overall strategy of reducing both costs and the number of its external investment managers. But other factors could have been at play in the plan’s decision.

A plan the size of CalPERS, with more than $295 billion to invest as of the end of June, would need to deploy between 1 percent and 5 percent of its assets in hedge funds for such an investment to “move the needle,” or have a meaningful effect on the plan’s risk or return characteristics, Barron said.

The attempt by plans to deploy hedge funds to either increase the plan’s overall return or reduce its portfolio risk is challenging in any environment but is exacerbated when, like now, returns are low and it has become difficult to differentiate between managers, he said. Thus, if CalPERS had maintained its hedge fund program, it’s likely that the plan would have had trouble investing a portion of what would have been a hedge fund target of up to $14.5 billion, Barron said.

Funds needing to invest between $2 billion and $5 billion are best suited for hedge fund investments, he said. Their investments are large enough to command interest from the best fund managers and small enough to find enough of these managers to take on their money, Barron said.

Resort to Opportunism

In the case of the Pennsylvania system, Lewis said, its $26 billion plan has about 6 percent, or about $1.5 billion, invested in hedge funds. However, he said the plan’s target hedge fund investment is 12 percent, or a bit more than $3 billion.

Lewis, who has been on the job a little more than two months, admitted that finding good fund managers in which to implement the plan’s hedge fund strategy of reducing portfolio risk will be challenging. Nevertheless, he said the plan will be “opportunistic” in trying to invest its remaining $1.5 billion hedge fund target allocation.

Hedge fund capacity certainly isn’t a factor in all decisions to reduce pension fund investments.

For example, the New Jersey Investment Council voted in August to cut its target allocation to hedge fund managers by 52 percent. Hedge fund capacity “had no bearing” on that decision by the $71.4 billion plan, Joseph R. Perone, director of communications for the state’s Treasury Department, told Bloomberg BNA in a Sept. 6 e-mail.

To contact the reporter on this story: David B. Brandolph in Washington at dbrandol@bna.com

To contact the editor responsible for this story: Jo-el J. Meyer at jmeyer@bna.com

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