In recent weeks, we have seen a number of articles that are beginning to bring new light to the massive potential conflicts institutional investors face when investing in "hedge funds." In September, the California Public Employees' Retirement System (CALPERS) announced plans to eliminate 24 hedge funds and 6 hedge fund-of-funds totaling $4B of their $298B pension over concerns that they are too expensive and complex.
At the same time, Intel has been receiving attention regarding their custom target-date investment products and the impact of hedge funds on the investment cost of their plan to participants.
Whether the flexibility of hedge fund investments provides an opportunity to generate higher returns than traditional long-only investment strategies, can continue to be debated. What cannot be debated is that hedge-fund investment products continue to suffer from two features that the Department of Labor has long labored against.
- Hedge fund products are more expensive than long-only traditional equity and fixed income products.
- Hedge funds are less transparent in their strategy, holdings, and risks than traditional equity and fixed income products.
Increasingly, the analyses of hedge fund product returns are revealing that returns, whether exceptional or poor, are determined largely by their focused risk exposures (beta) and less by the success or failure of their investment manager (alpha).
As with all investment strategies there will be a bell curve of results with outliers on both ends, but given the known risks, plan sponsors, especially those sponsors of plans governed by the Employee Retirement Income Security Act (ERISA), should be cautious before jumping into the dark pool of hedge funds.