OPINION: Hedge Funds’ Tough Week

Terry Flanagan

It was a tough week for hedge funds.

On Monday, the giant California Public Employees’ Retirement System said it would eliminate its $4 billion hedge-fund program to reduce costs and complexity.

The amount of money being pulled is a drop in the bucket of the $2.8 trillion hedge-fund industry, but the news is disconcerting because CalPERS is a standard-bearer in the industry. No chief investment officer of a small or mid-sized pension plan will lose his or her job for following CalPERS’ lead, so it’s reasonable to expect some copycat moves.

The Sept. 15 CalPERS announcement — which explicitly stated that the decision was not based on the performance of the hedge funds — was bad enough, but then the next shoe to drop was the press (predictably) pouncing.

“Why Calpers Tired of Vampire hedge Funds”

“CalPERS to Dump All hedge Funds”

“Calpers Shows Master of Hedge-Fund Universe Have No Clothes”

Those were just a few of the follow-up headlines that preached to the Main Street USA choir that hedge funds are, in fact, the root of all evil.

I’m not here to defend hedge funds as the greatest thing ever. The sector does have its warts. Just a few months ago, a hedge fund marketer told Markets Media that he believes 80% of hedge funds aren’t worth their salt. This was a marketer mind you, who presumably would have a more optimistic view.

I briefly worked for a hedge fund, one time years ago in what now seems like a previous life. I came away unimpressed — it was essentially a portfolio manager who implemented his investment program with the support of a strategist, an assistant PM, a few analysts, and a trader. They were all smart people who brought skill and experience to the table, but at the same time, everybody put on their pants one leg at a time. How would this hedge fund consistently add value — in the form of excess returns, lower risk, or whatever else — by more than its quite-high management fees? The short answer is, it didn’t, and it no longer exists.

That fund was decidedly in the 80%.

But there is a 20%, or whatever the number may be, of hedge funds that do add value. These are the established places with extensive performance records — the Bridgewaters, AQRs, and Och-Ziffs of the world. These are the funds that numerous pension plans and other institutional asset owners have increased exposure to, and will likely to continue to do so. CalPERS’ exiting hedge funds may be the right move for that institution, but for another institution, adding hedge funds may be indicated.

To quote Mark Twain, reports of hedge funds’ demise are greatly exaggerated.

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