Toxic Mix Eats into Hedge Funds

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The wrath of investors: worst capital outflows since 2009.

Big public pension funds are slow-moving apparatuses. So dramatic shifts in investment decisions take a long time to be discussed and decided, and even longer before they’re felt by the investment community. But now they’re being felt – painfully.

In September 2014, the $300-billion California Public Employees’ Retirement System, the nation’s largest pension fund, announced that it would liquidate over the following year its investments totaling $4 billion in 24 hedge funds and six funds-of-funds; they were too complicated and too expensive.

Calpers interim CIO Ted Eliopoulos said at the time that, “at the end of the day, when judged against their complexity, cost and the lack of ability to scale at Calpers’ size,” the hedge fund program “doesn’t merit a continued role.”

And this ended pension funds’ post-financial-crisis love affair with hedge funds.

Hedge funds were supposed to help pension funds fill in their funding holes with higher returns. They were supposed to help pension funds fulfill their lofty promises to the retirees. Instead, hedge funds have deepened those holes with below-par returns – and some with spectacular losses. And to make the bitter fare go down better, they’ve decorated it with dizzying fees.

Calpers is the model for many pension funds. And its decision soon began to reverberate through the industry. Other pension funds chimed in. For example, last Thursday, the New York City Employees Retirement System voted to liquidated its entire $1.5 billion hedge fund program, a trustee told Reuters, “as soon as practicable in an orderly and prudent manner.”

Letitia James, public advocate for NYCERS, lambasted hedge funds for their “exorbitant fees” and lashed out at managers who “balk at negotiations for investor-favorable terms,” thinking they “could do no wrong, even as they are losing money.”

“If they were truly fiduciaries and cared about our members, they would never charge large fees for failing to deliver on their promises,” she told the Financial Times. “Let them sell their summer homes and jets, and return those fees to their investors.”

Hope, lousy returns, and high fees. A toxic mix.

And those fees are big: 2% of assets plus most commonly, for the lucky ones, 20% of profits. If these profits aren’t substantial, it’s a prescription for investor frustration.

Pension funds weren’t the only ones. The oil bust has mauled the finances of oil producing countries, and their sovereign wealth funds, such as those of Norway and Saudi Arabia, have been selling assets and withdrawing billions from hedge funds around the world in order to prop up their public finances and battered economies.

And now it has trickled down to the numbers – the worst numbers for hedge funds since 2009.

Capital outflows in the first quarter reached $15.1 billion, the largest quarterly outflows since Q2 2009, according to Hedge Fund Research, “as volatile markets and early quarter performance resulted in falling investor risk tolerance and led to redemptions from underperforming strategies.”

That made two quarters in a row of outflows, the first such pair since 2009.

While some funds picked up assets, event-driven funds and macro-strategy funds got hit the hardest; their capital declined by $8.3 billion and $7.3 billion respectively.

It didn’t help that hedge funds in the aggregate also lost money in the quarter: -0.7% according to the HFRI Fund Weighted Composite Index. The loss isn’t huge. But you pay the ultimate “smart money” hefty fees so that they earn a high return for you. And a loss like this doesn’t fit into the scenario.

Interestingly, while they lost money in the first half when stocks were heading south in a hurry and when the bottom fell out of junk bonds, they didn’t lose as much as the overall stock market index. At the time, the industry bragged about its ability to ride out market turmoil and volatility.

But then, in the second half of the quarter, when the S&P 500 shot up 15% and when junk bonds soared, they missed part of the rally. And so they didn’t quite make back what they’d lost in the first half. Even lowly index funds beat hedge funds in the quarter – as they have been year after year since the financial crisis!

Between capital outflows and capital evaporation, assets under management declined to $2.86 trillion. HFR’s report put it this way: “The volatile performance environment continues to be dominated by intense dislocations, sharp reversals, and rapidly shifting correlations across assets….”

Those words are not particularly soothing to pension funds. They too see the hedge-fund drama-queens showing up in the media. And they compare the results to those of index funds and their own portfolios. And they’re thinking: if index funds can beat hedge funds, and if we can do it too, why pay the fees?

So what does “another gored bear” – who’s famously stuck to his own business, real estate, and gold while lambasting stocks for years even as they have soared – do to try to “tilt the odds” in his favor in the “shabby world of money?” Here are his doubts and his thought process for a radical shift. Read…. The Man I’m Betting $5 Million On

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  17 comments for “Toxic Mix Eats into Hedge Funds

  1. theodore kumlander
    April 21, 2016 at 11:21 am

    Lofty promises to the retirees. Really? I was a public employee for 32 years. I paid in 3% of my pay into the pension fund and was promised a pension and i receive it every month. I assure you it is not Lofty.

    • Chip Javert
      April 21, 2016 at 11:52 pm

      So your pension isn’t lofty. Neither is a 3% contribution.

      I don’t mean to be disrespectful, but that’s not even 1/4 the total current employee + employe FICA contribution of 12.4% plus 1.4% for Medicare.

      The average current Social Security payout is less than $1200/month – divide that by 4 and compare to your pension.

      You can truly believe in the tooth fairy, but that doesn’t make her real.

  2. Dan Romig
    April 21, 2016 at 11:52 am

    For pension funds, the 72 rule for doubling is pretty damn hard to do in a ZIRP and NIRP landscape. Ask the Teamsters in the Midwest how they’re doing with their obligations. Hedge funds offered the Holy Grail, or so it was thought, but in reality, there is no way at present for pension funds to keep pace – and it’ll only get uglier.

    Thank you Central Bankster Cabal!

    • Johnny B
      April 21, 2016 at 5:42 pm

      Really good post.

      It is nearly impossible to be an active fund manager if you focus on fundamentals these days. Central bankers the world over change their tunes with the prevailing political winds to try and give the impression that debt fueled growth will eventually work….at least through the next election cycle. Currency manipulation only multiplies the issue (see Japan).

      When gov’t finds crony capitalists it fines them without admitting guilt while the investors and those trying to advise them have no recourse to the rigging they have been doing in currency, commodity, bonds etc. It is no wonder 60-80% of mutual funds are underperforming benchmarks.

      Hedge funds like to believe they are immune to the invisible hands but it is clear they are as clueless as average Joe investor in trying to navigate.

  3. Vern
    April 21, 2016 at 12:07 pm

    It’s about time!

    Wolf, I became a reader of Wolf Street from 1st reading your posts at the excellent Naked Capitalism blog.

    Returning the favor for your readers who haven’t discovered her, I highly recommend Yves Smith’s extensive, long term coverage of the Hedge / Pension Fund (particularly CalPers) mess.

  4. Petunia
    April 21, 2016 at 12:46 pm

    The cuts in benefits that will soon be imposed on the Teamsters Union retirees are sure to affect the elections. This has been known and brewing for months and nobody is talking about it. I expect things to get ugly. It’s the Teamsters.

    I remember a couple of years before the financial crisis seeing a Palm Beach county commission meeting on tv. The police were asking for an 8% pension contribution from the county based on all the high property values. One commissioner voiced concern that the values might not keep increasing at the same rate and was ridiculed by the other commissioners, as well as the police representatives. Two years later most of the county was in foreclosure. The values weren’t there and the tax revenue wasn’t there either. Most of the taxpayers funding these pensions don’t have pensions as generous, or at all, as the ones they fund for their public servants.

  5. OutLookingIn
    April 21, 2016 at 1:41 pm

    “Worst outflows since 2009”

    Wall street has suffered over $1.36 billion of outflow over the past 12 weeks and counting, as the in-the-know insiders take their cash and run.
    Where is this capital going? Safety. Any asset with a perceived safe haven.

    I watch any auction action of art, jewels, cars, antiques, wines, etc.
    A few recent high points. A 1966 Shelby Mustang selling for $128,000 A 1968 Maserati Ghibli Coupe selling for $162,000 A blue diamond selling for $40 million A private small lot collection of French wines, the cheapest bottle selling for $8,750

    Inflation is bounding up on ANY high end asset, that capital is fleeing to for a safe haven. The purchasers are concerned with preserving their capital, rather than a return on their capital.

    What the above portends is little to no confidence in “paper” wealth, as the recent strength in the gold and silver bullion prices have verified. Fear is a great motivator. Those who are at present financially complacent, will be caught off guard and have their wealth evaporate.

    • Dan Romig
      April 21, 2016 at 1:51 pm

      Hey, nothing like a nice, decanted ’59 Haut-Brion to go with some steaks on the grill.

    • robt
      April 26, 2016 at 2:54 pm

      Peaks in ” … art, jewels, cars, antiques, wines …” signify the end of the reflation cycle. The cycle was always: bonds, stocks, real estate, collectibles.
      The art market peaked about a year ago.
      With NIRP how to fill the pipeline with cash in the traditional way?
      How they’re going to reflate again is the big question. Helicopter drops? Massive currency debasement then start over exchanging new dollars for old? Complete deflationary collapse and start over?

  6. Chris
    April 21, 2016 at 4:08 pm

    Pension funds, individual investors, etc. had better find a safe haven before summer. Cash might be a good idea. We seem to be in a deflationary climate notwithstanding ZIRP and NIRP. Precious metals are probably not a great bet at this point but these waters are totally uncharted. Bottom line: the equities and bond markets are going to crash, not adjust, crash.

    • OutLookingIn
      April 21, 2016 at 5:05 pm

      Gold is the money of kings, silver the money of gentlemen, currency the medium of peasants and debt the lot of slaves.

      Cash will be trash. Actual tangible, physical assets are a wealth preserver.
      Deflationary? Yes, as the value of paper assets evaporates.
      Inflationary? Yes, as the value of physical assets rise higher.

      • Agnes
        April 21, 2016 at 7:14 pm

        During the great Inflation/Deflation debate in the gold/silver bugs community in 2001-2003 the conclusion was that cash would BRIEFLY be king between the period of credit contraction and catastrophic deflation. It seems simpler to me to not risk timing that event and to just buy stuff I need.

  7. Paulo
    April 21, 2016 at 6:03 pm

    Not all pension plans are created equal, obviously. In my working life I worked about 10 years in construction, 17 as a BC teacher, and off and on 15 years flying bush planes. Many years I worked all three careers at the same time. My favourite job is/was building, (if I had to choose), but all jobs were very rewarding in their own right. Only one career, teaching, offered a pension plan. Actually, there was no choice in the matter. If you work you pay into it. It was jointly funded and was strictly hands off as far as Govt. meddling and raiding of assets goes. It wasn’t always like that as the BC Govt in the 60s liked to fund their mega-projects with their employees pension savings. Anyway, teachers paid for 1/2 contributions and individual school districts paid the other 1/2…. of the current plan. They both manage it by committee, but use an investment group to do the real work and heavy lifting. It is in very sound financial condition. It is evaluated by actuaries under strict and transparent accounting procedures. All members receive regular updates.

    I have provided a link to FAQs if anyone is interested.

    It is a quick and interesting read.

    My best friend, who stayed full-time in aviation and makes between $100-$125,000/year flying helicopters 6 months of the year, is now freaking out because he does not have a pension beyond the Canadian Pension Plan (CPP) which pays about 50% of what the US Social Security plan pays. If he were to retire at 65 he would receive about $1500.00/month (between OAP and CPP). You could get by, if you had no debts. If you had a partner, who also has a work history of contributions, you could pool your benefits and probably do okay. However, you cannot have debt and still retire in Canada.

    Our pension plan pays out at 2% per year based on your best 5 years of earnings. Mine would be 34% of my best 5 years….minus a penalty for retiring early. The penalty is based on the difference. After 60 years of age there is no penalty…you just get your 2%/year. The maximum you could ever collect is 70% of wages…which takes 35 years of full-time employment to achieve (10 month year). That means 35 years of paying into it.

    Our Pension Plan was achieved by giving up salary for part of the contribution. The taxpayer pot is only so big. I remember for years my private sector buddies razzing me about my wage as they made much more than I did. Even some of my graduating students liked to tell me how much more they were making than me driving a gravel truck for their Uncle building logging roads, or working up north! One kid named Jimmy actually asked why on earth I paid all that money to go to university in order to teach school? So did my flying buddies. All I know is that I retired at 57 and they’re still working.

    Belonging to a pension plan forces you to invest and be prepared for your own retirement as a simple day to day rountine. The money/contribution is deducted at source. If the plan isn’t sound, you won’t get paid so members ensure it is sound and it stays sound. I paid approx $1,000/month into the plan. It wasn’t ‘free’,or a ‘perk’, like so many infer. It was not a Govt. promise that they now cannot keep due to current financial woes or tax revenue shortages; as members self-fund their benefits before they retire. (How, is answered in the website/link). If the future economy tanks and we lose it all, then so be it…we will all be in the same boat. All of us. (We’ll get by, at least I plan to, anyway). :-)


    • robt
      April 26, 2016 at 3:17 pm

      In Canada anyway, the private and Crown corporations have been giving IOUs (formally called ‘Letters of Credit’) for the past few years to cover solvency deficiencies in their pension plans. Just one example is Canada Post, whose plan has a solvency deficit of maybe 7 billion dollars (and that’s at current market peaks) that will never ever be payable from profits. The government will just pushing out the solvency payout dates further and further or maybe just change the solvency rules to pretend deficiency doesn’t exist. This can be rationalized in the sense that pension plans usually don’t have to wrap up and pay out at a specific point in time, but the specter of the Federal Government having to bail out all the government and Crown corporations’ pensions is looming. The private pensions I’m sure they couldn’t care less about.
      Old age pensions and Canada Pension can be paid just by printing money and/or increasing government deficits, hopefully until all currently qualified recipients die. An unfortunate result has been observed in many countries in the past, such as Russia, where your state pension ended up buying you a can of soup a month. Perhaps rationing, increasing age qualification, and tax increases will take care of the newcomers.
      Unfortunately, the new Liberal government has quadrupled the ‘budget’ deficit with their first spending list (i.e. budget) so even their tax-and-waste policies will be stretched to the limit.

  8. Kreditanstalt
    April 21, 2016 at 6:52 pm

    I’m waiting anxiously for some of the private pension funds to cut payouts.

    This has to happen with ZIRP; it’s a mathematical certainty in an economy in which “investment” (for yield) is dead and in which speculation, cannibalism and betting are all that remains.

    And when it starts to occur it will be a sign of not only deservedly falling North American living standards but of systemic honesty, in the same way these abandonments of hedge funds are the smoke hiding a fire…

  9. Markar
    April 22, 2016 at 11:08 am

    These poor billionaire hedge fund managers! Does this mean I’ll eventually be able to buy a home in Greenwich CT or the Hamptons for under $1mill?
    On a side note, it’s clear the central banks know that due to their destructive 0% policies they have to keep the stock market propped up despite the crappy fundamentals in order to prevent the pension funds from completely blowing up sooner than later

  10. discgman
    April 22, 2016 at 11:19 am

    I currently pay into the calpers system. I work in tech, so I am not making the kind of money others in my field do. I’m taking a pay cut for sure as I am only an hour or so from the bay area. But I put in about 1k with matching from employer into the fund every month. I get lots of paid time off, vacation and sick time. My quality of life and stress is very good. Im about 10 years in and Im hoping in another 10 years to retire with 50 percent of my highest earnings pay plus a small profit sharing of a previous employer. That plus social security should keep me at my current pay the rest of my life.

    Some pension funds in California were given too many perks. Retire at 55, full benefits and such at a time were there was money flowing steadily into local government coffers. Just look at Bell California where there was massive fraud as city managers were making more that the president of the united states and retiring at full pay. Or in Stockton and Vallejo were they were giving cops and firemen lavius pensions only to find themselves bankrupt cities after the markets crashed. It all depends on how much greed there are in city and state government and who is regulating it.

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