About five years ago, Kentucky started investing some of its public-employee pension money with hedge funds. Sure, fees were high but the funds came with the lure of high returns and could serve as a buffer if the market tanked.
By early November, Kentucky officials had had enough. They voted to start yanking $800 million from hedge funds including Pine River Capital Management and Knighthead Capital Management.
Disappointing returns were certainly a factor. But another reason was the public’s perception of hedge funds as highly risky and run by guys with penthouses and yachts, said David Peden, chief investment officer for Kentucky’s $16 billion portfolio. That was poison at a time when taxpayers were being asked to fork over more to close a 60 percent gap in pension liabilities.
“We’re in a situation where there’s a lot of eyeballs on what we’re doing because we are so poorly funded,” Peden said.
Kentucky is one of the latest among America’s biggest investors -- pensions, endowments and foundations -- that are souring on hedge funds after a 15-year romance.
Unhappy with mediocre results and high fees, pensions in states like Illinois, New York and Rhode Island are slashing their allocations to hedge funds. More than one in four endowments and foundations, from colleges to museums to hospitals, are doing the same or considering it, according to a survey by consultant NEPC. Many are demanding lower fees and better terms to stick around, and usually getting it.
All told, redemptions hit a 2016 peak in the third quarter when investors pulled a net $28 billion from hedge funds, the most since early 2009, according to Hedge Fund Research Inc.
The backlash is part of a broader rebellion that has seen an avalanche of money move from actively-managed funds to low-cost passive products like index funds. The $3 trillion hedge fund industry, however, has become the poster child for the sins of active management because it charges among the highest fees even as performance lags. That doesn’t sit well in the political world of public pensions and endowments. They face pressure to boost returns as an aging workforce enters retirement and tuitions rise.
Foregone Returns
“Hedge fund managers continue to reap hundreds of millions of dollars in fees, regardless of their performance, which is a rip-off at the expense of pensioners,” said Maria T. Vullo, who as superintendent of the New York Department of Financial Services is the state’s top financial regulator. She has estimated hedge funds cost her state’s retirement system $3.8 billion in fees and foregone returns over the last eight years.