Thoughts on the WSJ CALPERS story
Within the past 24 hours, The Wall Street Journal reported that the nearly $290 billion California Public Employees’ Retirement System (CALPERS) portfolio will reduce its exposure to hedge funds (alternatives) by 40%. It is estimated that CALPERS’ 2014 alternatives exposure is somewhere between $5.0 billion and $5.5 billion. Reasons cited for the potential reductions included high fees with lackluster returns.
Please understand this is not breaking news. In fact, Randy Diamond wrote about the CALPERS review in early May for Pension & Investments. As Mr. Diamond cited in that article, the review has been underway since the beginning of the year. Also, as cited within that article, the 2013 hedge fund portfolio return for CALPERS was +9.2%.
CALPERS grabbed the headlines because they are considered a pioneer for investment ideas and were among the first to allocate assets towards hedge funds in early 1990s. Other pension funds in Ohio, New Jersey, and Northern California have reduced, or are considering reducing, their hedge fund exposure this year.
The question for investors in the wake of the news is, “Should I act like an institution – in this case CALPERS – and reduce my alternatives exposure?”
If the S&P 500® Index (SPX) were trading at 750 and it was 2009 all over again, then I would suggest there are definitely more favorable asset classes to allocate towards than alternatives. If that were the investment landscape, I would argue along with CALPERS to reduce exposure to alternatives. But the news of the past 24 hours is poorly timed. The SPX is trading at all-time highs and absent of a 10% correction since 2012.
Now is actually a time to consider an allocation to the alternatives asset class. It is an excellent vehicle for investors to remain invested in risk assets while at the same time offering a prudent risk management strategy. We are all suspicious of the current pricing for risk assets; quality hedge funds can quickly neutralize the risk associated with any substantial correction. I consider exposure to hedge funds a “stop loss” for long-term investors, similar to “put protection” utilized by active traders.
I don’t disagree that there are probably too many hedge funds operating in the markets today. Consolidation might be a good thing. Poor managers should find other careers. But now is certainly not the time to reduce exposure to quality hedge fund managers with a long-term proven track record. Unless, of course, the SPX continues to melt up toward 2500 over the next 18 months with nary a correction. Hedge funds will more than likely underperform in that environment. That is a good risk to assume relative to reducing exposure now and the long-awaited correction subsequently unfolding.
Sorry, CALPERS, but the WSJ story actually makes me more nervous about the current SPX price level and eager for some quality non-cash risk management strategies. Don’t dismiss the asset class; dismiss the poor managers in the asset class first.