The hedge fund industry continues to expand its influence throughout the US economy and financial system despite having a lackluster performance record. The latest catch is a true whale, the California State Teachers’ Retirement System (Calstrs), a pension fund worth approximately $119 billion that serves roughly 880,000 active and retired school employees.
According to a September 2 report from The Wall Street Journal, Calstrs is seriously considering moving 12% of its portfolio — $20 billion — into “U.S. Treasurys, hedge funds and other complex investments.”
This extremely risky plan is, oddly, being described by Calstrs officials as a “risk mitigation strategy.” That by giving money to some of the riskiest investment vehicles in the financial system Calstrs is somehow balancing out its more conservative holdings in stocks and bonds. There is no evidence to support that belief.
Sadly, Calstrs could easily exacerbate its losses in more conservative investments by taking equal or greater losses with its more aggressive and complex hedge fund investments.
As noted by Barry Ritholz of Bloomberg, hedge funds have failed to beat a 60/40 mix of stocks and bonds every single year since 2002 and research into the way hedge funds work shows they not only fail to deliver better returns overall, but most hedge funds do not really make market neutral “hedges.”
In other words, the hedge funds that don’t implode are the ones that successfully ride a climbing market. Though hedge funds don’t beat the more basic conservative mix of stocks and bonds they do generate a ton of fees for the so-called “active” managers. A typical hedge fund works on a 2/20 model where a manager takes a 2% fee of all assets under management regardless of performance as well as 20% of all gains.
As David Sirota of The International Business Times pointed out, hedge funds and other alternative investment vehicles that Calstrs is considering providing billions to have been getting rich off of state and local governments via fees, some of which are reportedly not being disclosed.
Calstrs peer in the pension fund space, the also massive California Public Employees’ Retirement System (CalPERS), announced last year that it was dumping hedge funds to “reduce complexity and costs.” It stands to reason the returns probably weren’t so great either.
So why is Calstrs thinking about taking 12% of teachers’ pension money out of less risky, higher performing investments and putting it into hedge funds?