Calpers chief Marcie Frost says hedge fund fees remain ‘problematic’

Calpers, the US’s biggest public pension plan, has reinforced its aversion to hedge funds, declaring that their fees remain “problematic” even as the fund ramps up its allocation of assets to private equity.

Some investors are turning to hedge funds to help them benefit from — or at least weather — the likely shift in global monetary policy in the coming year. But Marcie Frost, chief executive of the $500bn California Public Employees’ Retirement System, told the Financial Times that Calpers was not inclined to shift.

“We all have to look at fees,” she said in an interview. “Everything we are paying to an outside manager is money that is not available to pay benefits.”

Frost’s comments came a month after Calpers, which has 2m members, approved plans to boost exposure to private markets against a backdrop of expected dimming returns from listed stocks. “We do think that public markets are a little overheated,” said Frost.

As part of a new four-year plan, Calpers’ board approved proposals to raise its allocation to private equity by 5 percentage points to 13 per cent and shift in to private debt with an allocation of 5 per cent. At the same time, global equity exposure was dialled down from 50 per cent to 42 per cent.

Calpers dumped its $4bn in hedge fund holdings in 2014 when the vehicles were under intense pressure over high fees and mediocre performance. Since then, average hedge fund management fees have edged down from 1.5 per cent of assets under management to less than 1.4 per cent, according to data provider HFR. Performance fees — a share of a fund’s profits that is paid to managers — have dropped from 18 to 16 per cent.

Private equity firms charge a fee structure similar to the model used by hedge funds, earning around 2 per cent of assets under management, and 20 per cent of the profits they generate. However, Calpers has been building its direct investment teams in an effort to save money on fees on these investments.

Frost said one of the biggest risks in executing the new strategy would be timing, and “tying up your capital with the right deals”. But generally she saw good opportunities in private markets, particularly private equity.

“We also think that private equity companies, because of the control they have over their portfolio companies, are really in a positive position to work on sustainability issues related to their investments,” she added.

Frost did not rule out going beyond 13 per cent in private equity “if there were good quality deals”, but this was not likely in the next four years.

Some analysts warn that funds risk being stuck with assets that are hard to sell in an emergency. “We are not concerned about liquidity,” said Frost. “We have sufficient ability to pay benefits if there was a market crash or a pretty significant downturn in the markets.”

Another part of the portfolio revamp — the addition of 5 per cent leverage, or borrowing, to the entire portfolio — has attracted criticism that the fund is gambling with taxpayers’ money.

“We hear a lot of different methods of how people have used leverage to boost returns. That is not our strategy,” she said. “Our strategy is around diversifying the portfolio. We think that by adding this leverage, timed appropriately, [it] does increase diversification by investing in less risky assets.”

The fund will not be “moving to 5 per cent overnight”, she added. “This is going to take some years to implement. We have to look at all the borrowing costs, we have to look at the opportunities that are coming and we have to lead our board through the implementation.”

Frost stressed that without the portfolio changes, expected returns would likely have dipped to 6.2 per cent, below the long-term target of 6.8 per cent.

Calpers’ new strategy was approved without a new permanent chief investment officer in post, following the abrupt resignation of Ben Meng, who formerly held the role, in August last year. Frost revealed that the search for a replacement had gone global, and that the delay in replacing Meng was partly related to pay.

The CIO role was not part of the fund’s long-term incentive plan, she said, a quirk that has now been fixed. “Compensation matters,” she said.

Dan Bienvenue assumed the role of interim chief investment officer following Meng’s departure, with Calpers expecting to announce a new CIO in the first quarter of next year.

Additional reporting by Laurence Fletcher