By Susan Barreto
All of us in the prognostication business agreed that 2012 was the year that returns would matter, but little did we know that the hedge fund allocations would continue to grow despite weak performance across the board.
Like Icarus flying too close to the sun, investors have learned a little bit about flying to the giddy heights of alpha possibilities, and how hard, and indeed fatal, coming down can be. In the US, institutional investors of all types have reported hedge fund returns averaging less than 1% a month in 2012.
In cases, such as at the Illinois Teachers’ Retirement System and the Pennsylvania Public School Employees Retirement System, hedge fund returns for the year ending 30 September, 2012 hovered at a dismal 3%. At the New Jersey Division of Investment (see story on page 10) returns for the year ending 31 August 2012 fared slightly better at 4.54%. The State of Wisconsin Investment Board, meanwhile, posted a return of -1.4% for the first year of investing (see page 8).
This is a far cry from where we were in 2011. According to research from consulting firm Cliffwater, the strongest hedge fund portfolio returns for the year ending 30 June 2011 were at Mississippi Public Employees (26.8%), Missouri Public School Employees (18.8%), Missouri Public Education Employees (18.2%), California State Teachers Retirement System (13.6%) and Pennsylvania Public School Employees (13.2%).
At the end of 2011, InvestHedge was concerned that the passive investing driven by a handful of consultants of large institutional investors could lead to a detrimental sell-off of underperforming hedge funds, which in turn could impact other investors. While some hedge funds experienced significant redemptions this year, these managers were not put out of business as the majority of new institutional mandates still go to firms with $1 billion or more in capital.
What has changed in the past year is that institutional investors are not shy about becoming a greater percentage of a manager’s assets. Trustees revamped their policy allocation at the University of California (see story on page 8) in a bid to allocate to smaller managers.
But for all that new-found freedom it remains to be seen whether or not new smaller managers will be a compelling sell to a group like the University of California. A staffer at another US endowment sees the argument of being a significant investor in a smaller manager as potentially risky, especially when it comes to revenue sharing and possible headline risk should a hedge fund go out of business.
The New Jersey Division of Investment prefers to make a minimum $100 million investment in a fund to get some benefits of scale, according to CIO Tim Walsh. However, he does not want to hold 20% of a fund, so most managers with $500 million in assets or less cannot be considered.
Global hedge fund firms with $1 billion or more in assets seem to be firmly entrenched in the institutional marketplace despite some troubling performance figures. The truth of the matter is as funds of hedge funds and other investors such as Ohio SERS continue to rebalance portfolios (see Ohio SERS, page 5), the ability to know whether a single investor’s investment has grown overnight to 50% of a fund is difficult to track.
Knowing where fellow investors are allocated has never been so valuable. But what will be even more precious in 2013 is sustainable alpha. Until hedge funds prove their worth to the institutional investor’s bottom line, the future growth of the industry remains uncertain.