Skip to main content

Big pension fund has valuable lesson for little investor

When one of the world's biggest, smartest investors gives you a tip, it pays to listen.

In this case, the tip comes courtesy of the California Public Employees' Retirement System (Calpers), the largest pension fund in the United States, and it's something all of us can apply in our portfolios.

The message? Forget about expensive attempts to outwit the market. Focus instead on reducing your investment costs.

Story continues below advertisement

The announcement this week that Calpers would be ditching all its hedge fund investments amounts to a slap in the face for the $2.8-trillion (U.S.) global industry that has grown up around the notion that a handful of brilliant money managers can reliably beat the market, or at least smooth out its volatility.

Calpers' decision, by itself, will have only a limited effect on the hedge fund business because its investments in that area amount to only about $4-billion of its $300-billion portfolio. But the California pension giant is seen as an industry leader and its move is nearly certain to cause other large investors to rethink their love affair with hedge funds.

What's less clear is whether the decision will have similar effects on small investors. In an ideal world it would, because it demonstrates that even a huge, sophisticated investor like Calpers is growing disenchanted with the notion of picking superstar investors. More important, it thinks, is trying to invest wisely at the lowest possible cost.

It's about time for such an acknowledgment of reality. Actively managed mutual funds have long demonstrated an inability to beat low cost, market-hugging index funds over the long haul. Now hedge funds are facing similar scrutiny.

These investment vehicles got their name because they were originally conceived of as a way to "hedge" risk. Early hedge funds would take both long and short positions, allowing them to make money both when markets soared and when they tanked.

Or at least that was the theory. In practice, "hedge funds" quickly became a catch-all term for professional investors who would make aggressive bets and pursue exotic strategies, often with the aid of borrowed money.

The results were about what you would expect from any situation in which hundreds of bright people are given large amounts of funds to gamble. A few (think George Soros or Julian Robertson) did very well. Many didn't.

Story continues below advertisement

A study by Ilia Dichev of Emory University and Gwen Yu of Harvard found that hedge funds, as a group, produced profits for their investors that were below market returns between 1980 and 2008. The average payoff from the clients' perspective was barely above what they could have earned by sitting in government bonds.

Hedge fund returns have been particularly ugly since the financial crisis, with the HFRX Global Hedge Fund Index lagging far behind the world's leading stock markets. Calpers, which has been investing in hedge funds for 12 years, evidently decided it had finally had enough.

A big part of the problem with hedge funds is their lofty fees. It's typical for a hedge fund manager to charge 2 per cent of assets under management as well as 20 per cent of profits. That may provide a powerful incentive to perform well but it also provides a strong motivation to take risk in pursuit of big returns – one reason that many hedge funds fail to survive for more than a few years.

Rather than playing the unpredictable hedge fund game, Calpers is focusing on what it can control – expenses. "Reducing costs remains paramount," it declares in its annual report. It prides itself on managing its huge portfolio for a management expense ratio that amounts to about half a cent for every dollar invested.

By comparison, many Canadian investors pay more than 2 per cent a year on their investment portfolios. By shifting to lower-cost mutual funds and ETFs, they could shave their costs considerably and become a bit more like one of the world's biggest, smartest investors.

Report an error Editorial code of conduct
Due to technical reasons, we have temporarily removed commenting from our articles. We hope to have this fixed soon. Thank you for your patience. If you are looking to give feedback on our new site, please send it along to feedback@globeandmail.com. If you want to write a letter to the editor, please forward to letters@globeandmail.com.

Welcome to The Globe and Mail’s comment community. This is a space where subscribers can engage with each other and Globe staff. Non-subscribers can read and sort comments but will not be able to engage with them in any way. Click here to subscribe.

If you would like to write a letter to the editor, please forward it to letters@globeandmail.com. Readers can also interact with The Globe on Facebook and Twitter .

Welcome to The Globe and Mail’s comment community. This is a space where subscribers can engage with each other and Globe staff. Non-subscribers can read and sort comments but will not be able to engage with them in any way. Click here to subscribe.

If you would like to write a letter to the editor, please forward it to letters@globeandmail.com. Readers can also interact with The Globe on Facebook and Twitter .

Welcome to The Globe and Mail’s comment community. This is a space where subscribers can engage with each other and Globe staff.

We aim to create a safe and valuable space for discussion and debate. That means:

  • Treat others as you wish to be treated
  • Criticize ideas, not people
  • Stay on topic
  • Avoid the use of toxic and offensive language
  • Flag bad behaviour

Comments that violate our community guidelines will be removed.

Read our community guidelines here

Discussion loading ...

Cannabis pro newsletter