Pension plan pressure on hedge funds was entirely predictable

News Report: Netherlands’ health and social sector Pension Plan to “eradicate” Hedge Funds from portfolio

First it was the California Public Employees’ Retirement System, and the trend has now extended to the Netherlands. Hedge fund allocations are under review, and there are plenty of reasons to assume this will continue as equity markets remain volatile…whipsawing every hedge fund that wasn’t truly market neutral. Pension plans need external managers, of this there is no doubt.

But which model? The questions are always the same: what are we paying for, why is there no “clawback” (see prior post “No one is surprised, but whose to blame?” Sept. 21-06), and where do you fit into my asset allocation strategy? The traditional Hedge Fund structure is not geared for the pension plan world, as I pointed out almost 8 years ago in the wake of Amaranth’s demise:

If you read the fine print, you get a sense of why it is inconceivable that pension funds can continue to support the idea that hedge fund managers:

– have a zero cost of capital
– pay out all of the “promote” based upon a single year’s performance rather than the performance of the team over the life of a fund
– do not ask the team to sign guarantees should the fund explode, and the promote that was paid earlier in the life of the fund is no longer “earned” based upon the fund’s overall performance

I was a bit ahead of my time, but the issues haven’t changed despite the passage of time.

That’s not to say that Trustees shouldn’t allocate capital to the Hedge Fund asset class. I’ve done it myself, in fact, via one or more plans where I had to vote in favour or against a specific manager allocation. As an industry, assets continue to flow to the sector despite the recent bad press. According to Preqin, $355 billion was raised last quarter and assets under management surpassed $3 trillion.

It was interesting to see that CPP Investment Board started 2015 as though it’s still 1985. When asked by the Globe for its allocation to hedge funds, CPPIB spokeperson reported that “we do not break out that number”, unlike Ontario Teachers Pension Plan and the Caisse de Depot, which gladly shared the very same information with the media. The CPPIB’s refusal to provide basic data on a subject of interest will come as no surprise to any of you (see prior representative post “12 questions CPP Investment Board won’t be answering on BNN today“).

With $3 trillion in AUM, and a plethora of rock star PMs commanding the spotlight on CNBC each and every day, the hedge fund asset class is here to stay. Change may be in the offering, however, so that higher profile institutional investors don’t rush for the exits, vacating the sector and its “heads I win, tails you lose” structure. Mega buyout funds have had to make their limited partnerships more investor friendly over the past 24 months, demonstrating the power of the Limited Partner universe when it gets an idea in its head.

MRM