Jamie Hyndman: Removing a Hedge

by Jamie Hyndman, Mawer Investment Management

It’s only one data point. But it caused quite a stir in institutional investment circles.

Last week, the California Public Employees’ Retirement System (Calpers) announced its plans to completely eliminate its hedge fund investments, which include 24 hedge funds and six hedge fund-of-funds valued at $4 billion. Calpers stated that the primary reason for the move is that they wanted to “reduce complexity and costs.”

If it were anyone else this news release might have been overlooked, but Calpers is the largest public pension fund in the U.S. with approximately $300 billion in assets under management. Needless to say, others will certainly take note and reflect on the relevance of Calpers’ decision.

The debate over hedge funds has raged for decades now. Hedge funds certainly do have the potential to play a diversification role in a balanced portfolio – they invest using methods that are uncorrelated to traditional long-only markets. And in some cases, the value of diversification is tremendous. For example, a foundation that wants to make regular grants to its charities needs a relatively stable market value or else it may not be able to achieve its mission.

But hedge funds are also often plagued by a number of shortcomings that have repeatedly called their efficacy into question. In addition to the cost and complexity issues highlighted by Calpers, illiquidity, transparency, regulatory, and performance concerns have also been cited.

Hedge funds can add diversification to a portfolio, but at what price? Higher fees, not being able to understand the investment strategy, not knowing the underlying holdings and exposures, and not being able to get out when desired are all high prices to pay for diversification. For investors that focus on long-term returns, it’s questionable whether the fees are worth it.

In fact, this applies to all active investment managers. Investors need to make sure the manager they choose has reasonable fees, an understandable and consistent process and transparency regarding their holding information.

Jamie Hyndman

Originally at: Mawer Investment Management Blog