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Hedge Funds Charge Too Much for Returns, Calpers Says

Date: Friday, February 9, 2007
Author: David Clarke, Bloomberg.com

(Bloomberg) -- Hedge funds charge too much in fees for performance that frequently mimics major stock indexes, said Russell Read, chief investment officer of the $225 billion California Public Employees Retirement System.

Hedge funds typically charge a management fee of 2 percent and keep 20 percent of any investment gains. That's unjustified when managers just track market indexes, Read said yesterday. The average hedge fund rose 13 percent last year, lagging behind the 13.6 percent increase of the Standard & Poor's 500 Index, data compiled by Chicago-based Hedge Fund Research Inc.

``We can get average market risk very cheaply,'' Read said in an interview at the Institutional Fund Management Conference in Geneva. ``We hate paying a performance fee for something we can get very cheaply.''

Fees didn't dissuade investors from pouring a record $126.5 billion into hedge funds last year, according to Hedge Fund Research. Calpers, the largest U.S. public pension fund, has about 2 percent of its assets in the funds and plans to increase that proportion to 3 percent in the next three years.

More than 8,000 hedge funds globally oversee $1.4 trillion. The private pools of capital allow managers to participate substantially in the gains of the money invested.

`Like a Charity'

Eight of every 10 hedge funds don't provide the returns to justify the fees they charge, according to Harry Kat, a professor at the Cass Business School in London. After surveying as many as 2,500 hedge funds since 1995, he concluded that in 80 percent of cases the investors would have been better off putting their money elsewhere.

``The bottom line is it's like a charity where you give these people lots of money, they make a really good living out of it, and they provide you with returns that are substandard,'' he said in an interview at the conference in Geneva.

The fee system for hedge funds may eventually evolve to allow those who outperform markets to get paid more than those who ride market returns, Read said.

``We have no problem paying high performance fees for a manager's selection, but we find taking on average market risk inherently unsatisfying,'' he said.

Calpers of Sacramento, California, paid out $500 million in fund management fees last year.

`Black Boxes'

Figuring out how much of a fund's returns are the result of risks the manager is taking and how much reflects rising markets is almost impossible, said Carol Verkoeyen, who works on allocation and research at Stichting Pensioenfonds ABP, the largest pension fund in Europe, at the Geneva conference.

``Hedge funds are like black boxes,'' Verkoeyen said. ``They charge these high fees and we don't actually know if their returns are coming'' from manager skill or market gains.

Investing with money managers who provide returns similar to the stock market ``is one of the biggest dangers when investing in hedge funds,'' said Hasse Joergensen, who oversees the 40 billion-euro ($52 billion) Sampension in Denmark.

Pension funds in particular have been attracted to hedge funds to cover increasing liabilities as retirees live longer. Hedge funds often use leverage to take bigger bets than traditional funds and seek to make money in falling as well as rising markets.

Hedge funds' ability to go short -- borrowing shares and selling them to benefit from a drop in price -- may prove an advantage after four years of market gains, said John Godden, who runs London-based IGS Group, which invests in hedge funds.

``When equities fall off a cliff, hedge funds look really smart, while an index fund would fall in value,'' Godden said.

Lars Rohde, who oversees the 60 billion-euro ATP fund in Denmark, is refraining from investing in hedge funds until he's convinced the performance is superior to other investments and that the fees are justified.

``We have got to believe in the business model.'' he said. ``We are yet to be convinced.''