U.S. pension funds put brakes on hedge fund bets

Date: Thursday, November 6, 2008
Author: Svea Herbst-Bayliss, Reuters.com

BOSTON (Reuters) - The love affair between U.S. pension funds and hedge funds is cooling.

After helping the hedge fund industry double their assets to $1.7 trillion over the last three years, pensions funds, in their search for plump returns, are reconsidering their commitments.

The pension funds have relied on hedge funds for years to help meet long-term obligations, but recent heavy losses at the loosely regulated portfolios are causing them to think twice.

"There are people saying 'Whoa, wait a minute here,' and public funds are very much reassessing their plans to invest in hedge funds," said Richard Ennis, chairman of investment consultants Ennis Knupp & Associates.

"There is a sense now that pension funds will be much more discriminating in which hedge funds they pick," he added.

In the short term, investment committees at some pension funds are stepping on the brakes, if only temporarily, worried over worst-ever returns and long investment lockups, according to industry insiders.

In September, the School Employees System of Ohio, which had planned to invest 10 percent of its $11 billion portfolio in hedge funds, decided to stop investing directly with them for a time, according to fund spokeswoman Laurel Johnson.

Florida's government workers, who have already put money into private equity and real-estate investments and are permitted to put money into hedge funds, have shied away.

"We have been cautiously evaluating our options for quite some time, but we are not in them yet," said Dennis McKee, spokesman for Florida's State Board of Administration.

Other pension funds that have already committed money are pulling some cash out, managers familiar with their negotiations have said.

To meet the withdrawals by year's end, several so-called funds of hedge funds -- long popular among pension funds because they reduce risk by selecting a portfolio of funds -- have liquidated some investments, industry officials said.

Still, some pension funds are still expected to keep investing in them to help meet their growing long-term liabilities.

ANXIETY OVER LOSSES

Ever since the California Public Employees' Retirement System, the largest U.S. pension fund known as Calpers, picked a handful of hedge funds in 2002 to help invest $1 billion, dozens of funds that manage retirement money for public employees such as teachers, police officers and transit workers have followed suit.

But now, the new wave of nervousness comes as the Standard & Poor's 500 stock index .SPX has lost 31.5 percent this year, and the average hedge fund return is down 20 percent, according to data from Hedge Fund Research.

This fiscal year, most public pension funds are not meeting the approximately 8 percent returns required by their actuaries to fulfill the defined benefit pensions paid to retirees, several consultants said.

"People are realizing that hedge funds, while they endeavor to be total return investments, were exposed to credit risks and equity risks, just like many other investments," said David Hammerstein, chief strategist at Yanni Partners, a division of GBS Investment Consulting LLC.

Hedge funds "have experienced withdrawals from all types of investors, including pension funds, and I think the trustees who are most nervous now are probably the ones who were nervous going in," he added.

With other parts of their portfolios tumbling, some pension funds have exceeded the percentage their trustees permit them to allocate to hedge funds, consultants said.

While no one expects pension funds to abandon hedge funds completely, managers and industry consultants expect pension funds to become much more selective.

Few pension funds will want to have their money locked up for years, as hedge funds have often required, investment consultants said. They will also demand to know more about how hedge funds actually make money.

"People are looking to us to help assess the risks, and there is going to be much greater scrutiny and understanding of the risks and investment disciplines at the funds we look at," said Michael Rosen, principal at Angeles Investment Advisors.

(With additional reporting by Karen Pierog in Chicago and Michael Connor in Miami; editing by Jeffrey Benkoe)