The country's largest pension fund has inadvertently provided a seal of approval to financial advisers who have been accessing alternative strategies via registered mutual funds and other exchange-traded products.
The California Public Employees' Retirement System, commonly known as Calpers, announced Monday it is eliminating its $4 billion exposure to hedge funds for reasons largely related to high fees.
For financial advisers — many of whom pay close attention to how the institutional money represented by pension funds and endowments invests — the move feels like justification of the less-expensive, more-regulated and more-liquid route of liquid alternatives.
“It says a lot about liquid alts and how disruptive they have become to the overall alternatives space,” said Thomas Meyer, chief executive of Meyer Capital Group. “I think a lot of endowments and pension funds are exiting hedge funds. If they're going to keep the alternative investment exposure, they're absolutely going into liquid alts.”
Considering Calpers total pension fund is $298 billion, the $4 billion allocation to hedge funds is relatively small. But to move entirely out of private hedge funds gives some proponents of liquid alternatives a new sense of vindication.
"Lower costs and simplicity are hallmarks of liquid alternatives, compared to hedge funds, and that is why institutional use of liquid alternatives is growing,” said Rick Lake, co-chairman of Lake Partners Inc.
The pressure is clearly on hedge fund managers to justify their fees, which typically include a 20% performance fee on top of a 2% management fee. Most alternative strategy mutual funds have expense ratios of less than 1.8%.
According to Calpers' figures, the pension fund paid
$135 million in hedge fund fees for the fiscal year ended June 30.
The biggest threat to hedge funds is coming from the mutual fund space, which now offers 465 alternative strategy mutual funds with $161.5 billion under management, according to Morningstar Inc.
That compares to 431 funds and $140.8 billion at the start of the year. At the end of 2008, in the heart of the financial crisis, there were 217 liquid alternative funds with just $37.7 billion under management.
“Through alternative mutual funds, institutions can now diversify their alternative investment allocations across the liquidity spectrum,” Mr. Lake said. "Unlike hedge funds, alternative mutual funds generally do not charge incentive fees. Also, with a single ticker, and freedom from complex paperwork, alternative mutual funds are user-friendly."
Bob Rice, managing partner at Tangent Capital, acknowledged the significance of a major player like Calpers stepping away from hedge funds, but added that the pattern of institutions becoming more mindful of what they are getting for the higher fees is well documented.
“All the early studies say the liquid alts perform as well or nearly as well at hedge funds, and whatever performance lag there is can simply be seen as a premium for liquidity, lower cost, transparency, simplicity and regulatory safeguards,” he said.
This year through August, the Hedge Fund Research Index gained 4%, while the S&P 500 gained 9.9%. Last year the S&P gained 32.4%, while the HFRI gained 9.1%.
The last time the hedge fund index outperformed the S&P was during the heart of the financial crisis in 2008, when the S&P lost 37% and the HFRI fell by 19%.
Like hedge funds and other private investment vehicles, liquid alt mutual funds come in a variety of flavors.
Of the 14 subcategories tracked by Morningstar, the performance this year has ranged from a gain of 16.5% for leveraged debt funds to a decline of 18.7% for inverse equity funds.
“I would think the liquid alts space would be able to take advantage of institutional investors moving out of hedge funds,” said Brad Alford, chief investment officer at Alpha Capital Management.
“The hedge funds just aren't performing these days,” he added. “With liquid alts, if the returns aren't appealing you can at least get out whenever you want.”
