Wednesday, September 17, 2014

The Emperor Has No Clothes

There was a very important announcement earlier this week that will likely have a major impact on the investment industry. The California Public Employees' Retirement System (CALPERS) announced Monday that it will be exiting its $4 billion investment in hedge funds over the next year. CALPERS has long been a bellwether for the pension and endowment investment universe.  This announcement could mean that many other pension funds will follow suit and divest from hedge funds..

We have never been fans of hedge funds. They are extremely expensive, illiquid, and non-transparent. This is exactly why CALPERS has decided to dump hedge funds, stating that they are too costly and complex to justify keeping them in their portfolio.  It's also true that the promise that hedge funds can offer superior investment returns in any market environment has not proven to be true. Here's a quote and chart from the Wall Street Journal's article about CALPERS decision:

"Hedge-fund tracker HFR's composite index, which measures the equal-weighted performance, after fees, of over 2,000 funds, has been underperforming the passive bond-and-stock portfolio since 2009. During the crisis year of 2008, it lost 19%, only marginally better than the index fund's 22.2% loss. That performance made it a bit harder to accept the idea that hedge funds' ability to offer downside protection justifies the hefty fees they charge—typically a 2% management fee and 20% of investment profits."

It's very easy for investors to be seduced by hedge funds with the idea that really smart people with really big computers can somehow outperform the market. It turns out that this is much easier said than done. Instead of being masters of the investment universe, it turns out that most hedge fund managers are like emperors with no clothes. We applaud CALPERS decision to call out these naked money managers.  ~FSB