The Real Reason CalPERS Divested $4 Billion in Hedge Fund Investments

But is the extra hedge fund expense worth the risk?

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Bloomberg recently reported that the California Public Employees’ Retirement System (CalPERS) plans to divest their entire $4 billion investment in hedge funds. CalPERS is the nation’s largest public pension fund with assets totaling $298 billion, as of July 31, 2014. The fund administers health and retirement benefits for 3,090 public employers and has more than 1.6 million members in its retirement system. CalPERS is a giant in the pension community and their decisions carry a lot of weight.

The CalPERS board members said their decision to eliminate 24 hedge funds and six hedge fund-of-funds – an investment in a variety of hedge funds – is because they’re too expensive and complex. In my May 2011 post, “Hedge or Hoax,” I explained that the typical fund management fee schedule is referred to as two and 20, which means the fund manager takes 2% of the assets under management plus 20% of the profits. The trend in the investment industry has been to lower fees. While this trend has been evident in the mutual fund industry, there has been relatively no reduction in fees among hedge funds.

The Bloomberg article also reported that the CalPERS decision was not related to performance of the hedge funds in their program. Hedge funds, on average, carry more risk than many investments and, in theory, should produce a higher return.

But is the extra expense worth the risk?

CalPERS’ stated return goal for their portfolio is 7 ½%. The annualized rate of return on its hedge fund investments over the last 10 years is 4.8%. The 10-year return for the S&P 500 index was 8.1% through September 30, 2014. The Barclays US Aggregate Bond index had an average return of 4.6% for the same 10-year period. Performance may have had some influence on their decision after all.

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