This week CALPERS officially confirmed a decision pre-announced already a few weeks ago.  The large California pension fund is exiting entirely its hedge fund position, an exposure that totals $4 billion and represents just a little more than 1% of the entire fund portfolio.

Given the size of CALPERS and its weight in the investment community, the decision drew scrutiny and stirred a lot of controversy.  CALPERS stated that the decision was driven by an analysis of the complexity of the investment versus its performance in relationship to its cost.  Their study found that to move the needle, the investment should have been upped to at least $10 billion and that CALPERS committee did not find it a viable option and decided to liquidate instead.  CALPERS also subtly implied that the cost was not worth the headache as they reportedly spent $135 million in fees over the last financial year for performance that did not match the S&P 500 index.

While I agree that the size of CALPERS hinders the ability to fully exploit the benefits of hedge fund diversification, I wholly disagree with almost all other rationales used by the pension fund.

For starters, one should wonder where these $4 billion will be redirected.  If they will be moved to traditional assets such as large equities and bonds just in the name of lower fees, the timing is ludicrous.  Most pension funds always increase their positions to Alternative Investments after equity busts; one of the largest increase happened after the 2008 crisis and CALPERS itself started the program in 2003 after the 2000-2002 bear market.  Divesting now after equities had such a great run sound a lot like buying high and selling low.

Hedge funds should not be benchmarked against the performance of the S&P 500 index and in fact hedge funds should not even be evaluated as an asset class. They are investment tools that allow an investor to access niche strategies where alpha – or the specific money manager’s skills – make a difference.  Hedge funds become particularly helpful in asset allocation precisely when volatility is projected to rise as it may be the case at this juncture.

What may transpire from CALPERS’ statements is the fact that they just do not have the proper infrastructure and know-how to analyze, select and manage this allocation. I do wonder however, what they got in return for the additional $40 million plus they gave pension fund consultants whose job is exactly that of performing due diligence, selection and advising on hedge funds.  Perhaps the problem with fees paid by CALPERS should be revisited and investigated.  Indeed, the problem with fees is understanding when to pay them and when not to pay them.

 Alpha is rare and therefore expensive; however, when needed and when accessible it should be purchased.