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Eric D. Schwerin
Rosemont Seneca Partners, LLC
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Big investors say will stick with hard-pressed hedge fund sector

Institutional investors plan to put more money into hedge funds this year in spite of lacklustre investment performance and two of the world’s biggest public pension funds deciding the sector is no longer worth its high fees.

New data suggest that investors such as pension funds are willing to stick by the hedge fund industry following recent decisions by Calpers in the US and Europe’s second-largest pension fund PFZW to axe their allocations.

An annual poll by Preqin of large institutional investors found that 26 per cent plan to increase their hedge fund exposure this year, with 16 per cent planning to reduce it.

The findings come after hedge funds had their worst year of investment performance since 2011, and after last week PFZW, the Dutch healthcare workers’ pension fund, announced it had cut €4bn of investments in the sector because of poor returns, complexity and high costs.

PFZW said in its letter last week that hedge fund performance had not justified the fees it had paid, and criticised hedge funds’ “often limited concern for society and the environment”.

Once the preserve of wealthy individuals, hedge funds now draw more than a third of their $3tn of assets from pension funds, many of which are in deficit and facing mounting scrutiny for how they manage their investments.

Hedge funds, which already have attracted criticism from investors such as Warren Buffett for their high fees, have as a result come under greater pressure to justify their costs as they derive more of their fees from the pensions of ordinary workers.

According to the Preqin survey most respondents say they are happy with hedge fund performance and plan to keep their allocations steady.

The findings will relieve many in the hedge fund industry after a year when returns reached only 3.6 per cent according to HFR, and Calpers decided in September to axe its $4bn allocation to the industry. The California pension fund said such funds were too expensive and too complex to monitor.

Respondents to the Preqin survey, which polled 134 of the world’s largest institutional investors, continue to view hedge funds as a way to generate returns that have less risk than traditional stock and bond portfolios, a view that will be tested only through the next market downturn.

Peter Laurelli, head of research at data provider eVestment, said the $3.1tn hedge fund industry had its best year of inflows in seven years in 2014, and that he expects it to expand further in 2015.

“For every large institution paring down or getting out, there are offsetting institutional investors around the world doing the opposite,” he said.

The Preqin data contain areas of potential concern for managers, however. The number of investors planning to reduce their hedge fund holdings in the next 12 months, while still a minority, has doubled from a year ago.

Some investors have reduced their expectations of future returns from hedge funds, particularly public pension plans, which now expect an average of 5.4 per cent annually, down from 6.6 per cent three years ago. While this may relieve the pressure to perform, it may also explain why the number of respondents putting fees as their number one concern has doubled to 21 per cent since last year’s survey.

Hedge funds had their worst year since 2011 last year, according to HFR. Preqin’s report on the industry, including its survey of investors and hedge fund managers, is due to be published later this month.