The Big Issue

In an announcement last week, CalPERS called an end to its $4 billion hedge fund portfolio, citing scale, complexity and cost as key rationale for shutting down a program that has been in place for twelve years. The decision by the world’s fifth-largest pension scheme has prompted renewed criticism of the hedge fund industry, with much commentary pointing to a high fee structure and perceived poor performance in recent years as evidence of hedge funds’ limited added value.

In reality the debate is more nuanced. CalPERS’ size, not the performance of the asset class, played a large role in determining its stance today. At $300 billion, CalPERS is too large to benefit from the niche strategies in which managers still enjoy a real competitive advantage. Investors deploying significant capital are generally obligated to invest in funds with large AUM. This can eliminate from consideration the niche fund manager whose assets must remain smaller in order to maintain his or her market edge. For hedge fund investments, we firmly believe that ‘smaller is better’, a view backed by repeated empirical studies and by our own experience. A recent report by eVestment shows that between 2003 and 2013 small funds (<$250 million) outperformed large funds (>$1 billion) by 1.9% annually.

Indeed, the statement last week readily acknowledged that a primary reason for the move was “the lack of ability to scale.” With 24 hedge funds and six fund-of-funds, the average manager allocation in CalPERS’ portfolio – over $100mm – would overwhelm capacity in many of today’s most promising opportunities.

CalPERS enjoys a high profile position in the pensions industry and often sets the trend for investment decision-making. While we understand the challenges they face, smaller investors need not apply the same lessons to themselves but should instead focus on making their size work to their advantage.