17 July 2019

Hedge-Fund Bet Hits Pensions

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Large corporate pension funds have quadrupled the share of their portfolios invested in hedge funds over the past five years, according to an analysis of about 300 firms in the S&P 500 by Wilshire Consulting. During that period, those pensions have lagged behind the performance of the broader stock market in every year but one, according to Wilshire. Their return of 9.7% in 2014 was below 13.7% for the S&P 500, including dividends.

Private-sector pension funds now account for nearly one of every five dollars invested globally by institutional investors in hedge funds, leaping ahead of banks, endowments and insurers to become the second-largest buyer behind only public pension funds, according to Preqin, which tracks pension investments. Just four years ago, private pension funds were in a tie for fifth.

The move into hedge funds has its roots in the 2008 financial crisis, when pension funds suffered heavy losses from their investments in stocks. Many managers piled into bonds and other investments, including hedge funds, deciding they would provide better protection against future downturns because their strategies are designed to insulate investors from the variability of the stock market. But, buoyed by aggressive stimulus from central banks and ultralow interest rates, stocks embarked on a multiyear rally. That meant managers who moved money out of equities and into hedge funds and other investments have missed out on gains.

Hedge funds bet on and against markets and often have no formal constraints on the asset classes or geographic regions where they can invest. They are almost always open only to wealthy individuals or institutions. They have a track record of performing well in volatile markets, and some star managers consistently post outsize returns that justify the hefty fees.

Intel Corp. has significantly increased its hedge-fund allocation in recent years, saying it sees the move as a way to meet the company’s modest return targets over the long haul, particularly during periods when stocks and bonds underperform. Intel has a “healthy mix” of hedge funds, investing $2.6 billion, or 17%, of its pension assets to reach its annual return target of 5.4%, said Stuart Odell, Intel’s assistant treasurer for retirement investments. He couldn’t provide specifics on Intel’s recent performance but said the company was satisfied with the returns.

U.S. companies’ embrace of hedge funds has buoyed an industry that in recent years has come under fire from investors and politicians for charging hefty fees relative to performance. Some public pension funds, for example, have started to rethink their investments with hedge funds as they struggle to recoup crisis-era losses and close funding gaps. The California Public Employees’ Retirement System is walking away from its $4 billion investment in hedge funds over concerns about complexity, costs and whether it was large enough to affect overall returns.

Corporate and other private-sector pension funds aren’t under the same level of political scrutiny for their decisions because they aren’t investing taxpayer dollars. At the same time, costs for private-sector pensions have been kept in check, so they don’t face the same pressure to shoot for high returns. From 1998 to 2013, the number of traditional defined-benefit plans at Fortune 500 companies plummeted from 251 to 34, according to an analysis by Towers Watson. In a traditional defined-benefit pension plan, administrators choose where to put the money and employees receive a set payout at retirement regardless of how well or poorly the funds were invested.

The strategy of tilting a portfolio to hedge funds carries some risks. Because they charge such hefty fees, hedge funds have to significantly outperform other firms to return the same amount to investors. Also, pension funds have to lock up this money for several years, potentially putting stress on a pension fund’s ability to liquidate assets if there is an immediate need for cash.

The $26.4 billion retirement plan at auto maker FCA US LLC, formerly known as Chrysler Group LLC, for example, cut its hedge-fund investments from $2.4 billion in 2013 to $2.2 billion now. Those assets now represent about 9% of the portfolio. A spokesman for Chrysler, part of Fiat Chrysler Automobiles NV, declined to comment. Still, many pension managers and their consultants say that years of experience investing with hedge funds have helped alleviate their initial concerns.

Of the 100 companies with the largest market share in the S&P 500, 31 have pension plans, according to a Wall Street Journal analysis of Preqin data. Those companies have a combined stake of $32.5 billion with hedge funds, and nine of them have double-digit percentage allocations, according to the Journal analysis. As the pension fund inches closer to having enough assets to match its liabilities, Visteon says it is willing to forgo big returns to shield itself from an economic downturn.

Click here to access the full article on The Wall Street Journal.

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