Yves here. I was remiss in not writing up an important story yesterday, on how hedge funds are finally getting long-overdue pushback from investors on the lousy connection between fees and performance. We flagged this issue in our very first post in 2006. CalPERS admitted back then that hedge funds were not delivering any performance premium, despite the lavish fees. The giant pension fund rationalized staying in the strategy because it believed that hedge funds nevertheless provided returns that weren’t closely tied to stock market returns. We pointed out then that that was no justification for paying the lofty “2 and 20” (2% management, 20% carry fees) because you could construct that type of exposure, or hedge, much more cheaply, as hedge fund clones were staring to do.
The investment rationale for hedge funds has only gotten worse. Since 2012, hedge fund returns have become more correlated with the stock market, reducing its diversification benefit. Typical hedge fund returns have by many measures undershot equity market returns. And marquee funds, like Paulson & Company, Greenlight Capital, and Pershing Square, have badly underperformed, savaging the myth that institutional investors might tell themselves, if only they’d been more exposed to the really hot funds….
By Wolf Richter, a San Francisco based executive, entrepreneur, start up specialist, and author, with extensive international work experience. Originally published at Wolf Street
The wrath of investors: worst capital outflows since 2009.
Big public pension funds are slow-moving apparatuses. So dramatic shifts in investment decisions take a long time to be discussed and decided, and even longer before they’re felt by the investment community. But now they’re being felt – painfully.
In September 2014, the $300-billion California Public Employees’ Retirement System, the nation’s largest pension fund, announced that it would liquidate over the following year its investments totaling $4 billion in 24 hedge funds and six funds-of-funds; they were too complicated and too expensive.
Calpers interim CIO Ted Eliopoulos said at the time that, “at the end of the day, when judged against their complexity, cost and the lack of ability to scale at Calpers’ size,” the hedge fund program “doesn’t merit a continued role.”
And this ended pension funds’ post-financial-crisis love affair with hedge funds.
Hedge funds were supposed to help pension funds fill in their funding holes with higher returns. They were supposed to help pension funds fulfill their lofty promises to the retirees. Instead, hedge funds have deepened those holes with below-par returns – and some with spectacular losses. And to make the bitter fare go down better, they’ve decorated it with dizzying fees.
Calpers is the model for many pension funds. And its decision soon began to reverberate through the industry. Other pension funds chimed in. For example, last Thursday, the New York City Employees Retirement System voted to liquidated its entire $1.5 billion hedge fund program, a trustee told Reuters, “as soon as practicable in an orderly and prudent manner.”
Letitia James, public advocate for NYCERS, lambasted hedge funds for their “exorbitant fees” and lashed out at managers who “balk at negotiations for investor-favorable terms,” thinking they “could do no wrong, even as they are losing money.”
“If they were truly fiduciaries and cared about our members, they would never charge large fees for failing to deliver on their promises,” she told the Financial Times. “Let them sell their summer homes and jets, and return those fees to their investors.”
Hope, lousy returns, and high fees. A toxic mix.
And those fees are big: 2% of assets plus most commonly, for the lucky ones, 20% of profits. If these profits aren’t substantial, it’s a prescription for investor frustration.
Pension funds weren’t the only ones. The oil bust has mauled the finances of oil producing countries, and their sovereign wealth funds, such as those of Norway and Saudi Arabia, have been selling assets and withdrawing billions from hedge funds around the world in order to prop up their public finances and battered economies.
And now it has trickled down to the numbers – the worst numbers for hedge funds since 2009.
Capital outflows in the first quarter reached $15.1 billion, the largest quarterly outflows since Q2 2009, according to Hedge Fund Research, “as volatile markets and early quarter performance resulted in falling investor risk tolerance and led to redemptions from underperforming strategies.”
That made two quarters in a row of outflows, the first such pair since 2009.
While some funds picked up assets, event-driven funds and macro-strategy funds got hit the hardest; their capital declined by $8.3 billion and $7.3 billion respectively.
It didn’t help that hedge funds in the aggregate also lost money in the quarter: -0.7% according to the HFRI Fund Weighted Composite Index. The loss isn’t huge. But you pay the ultimate “smart money” hefty fees so that they earn a high return for you. And a loss like this doesn’t fit into the scenario.
Interestingly, while they lost money in the first half when stocks were heading south in a hurry and when the bottom fell out of junk bonds, they didn’t lose as much as the overall stock market index. At the time, the industry bragged about its ability to ride out market turmoil and volatility.
But then, in the second half of the quarter, when the S&P 500 shot up 15% and when junk bonds soared, they missed part of the rally. And so they didn’t quite make back what they’d lost in the first half. Even lowly index funds beat hedge funds in the quarter – as they have been year after year since the financial crisis!
Between capital outflows and capital evaporation, assets under management declined to $2.86 trillion. HFR’s report put it this way: “The volatile performance environment continues to be dominated by intense dislocations, sharp reversals, and rapidly shifting correlations across assets….”
Those words are not particularly soothing to pension funds. They too see the hedge-fund drama-queens showing up in the media. And they compare the results to those of index funds and their own portfolios. And they’re thinking: if index funds can beat hedge funds, and if we can do it too, why pay the fees?
So what does “another gored bear” – who’s famously stuck to his own business, real estate, and gold while lambasting stocks for years even as they have soared – do to try to “tilt the odds” in his favor in the “shabby world of money?” Here are his doubts and his thought process for a radical shift. Read…. The Man I’m Betting $5 Million On