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Streetwise Why hedge funds aren’t sweating the Calpers exit

Calpers, the largest U.S. public pension fund, manages retirement benefits for more than 1.6 million people, headquarters is seen in Sacramento, California in this October 21, 2009 file photo. The California Public Employees' Retirement System, the largest U.S. pension fund, said on September 15, 2014, that it will pull all $4 billion it has invested in hedge funds because it finds them too costly and complicated.

Max Whittaker/Reuters

Hedge funds are likely to keep a hold of public pension funds' investments, even as the largest pension fund in the United States waves goodbye to these strategic investment vehicles.

The California Public Employees Retirement System (Calpers) made waves Tuesday when it announced plans to exit its investments in two-dozen hedge funds. The move will trim $4-billion (U.S.) of hedge fund investment out of the nearly $300-billion portfolio the pension fund oversees. Some reports suggest that other pension funds could follow Calpers to the exit.

But industry watchers shouldn't expect a mass exodus, said a report by alternative asset class research firm Preqin.

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"With Calpers cutting back on hedge funds, there could be concerns that these public retirement systems are losing faith in the asset class as a collective," said Amy Benstead, head of hedge fund products at Preqin, in a statement. "For now at least, this does not seem to be the case, and in fact, there are more U.S. public pension funds than ever before allocating capital to hedge funds, and these investors are investing the most they ever have in the asset class."

Preqin's calculations show the average hedge-fund allocation of U.S. public pension funds' assets under management climbed from 7.2 per cent to 8.6 per cent in the last five years. Public pension schemes fund 44 per cent of hedge funds, and more than a third of them reported an uptick in pension fund investment in the first half of this year.

Although hedge funds have been criticized for their lacklustre overall returns despite their high fees, Preqin argues that the complaint undervalues the reason many of these large pension funds invest with the hedgies in the first place – the hunt for diversification. As Ms. Bensted puts it, "the importance of hedge funds as a source of risk-adjusted returns for these investors is likely to continue to prove attractive for U.S. retirement schemes."

And as Bloomberg View's Matt Levine points out, Calpers is a pension giant that favours an indexing strategy for its investments. The fund's size makes the cost savings of indexing attractive, he says, compared to spending more money to try to achieve marginally better results with more aggressive investment strategies.

Calpers itself also pointed out that its hedge fund exposure was too small to provide real diversification – particularly since part of Calpers' exposure was through six "fund of funds," which are hedge funds that split investments up between other hedge funds, often as a way for investors with less capital to get exposure to superstar managers. Calpers will also wind up these positions.

That's not to say that hedge fund performance didn't have anything to do with Calpers shaking up its allocations. Returns have been fairly uneven this year, Ms. Bensted notes. "In times like this, investor calls for changes in fee structures and better alignment of interests become more vocal, and this clearly has had an impact on Calpers' decision."

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