Oops!

A number of public pension systems moved aggressively into hedge funds following the Great Financial Crisis. What they were hedging is anyone’s guess given that cheap beta could be obtained at a 50% discount. But, allocate they did.

We aren’t proponents of using the return on asset assumption (ROA) as the primary objective for a pension plan preferring that plan’s specific liabilities, but it certainly is a good objective for the asset-side of the equation. Ten years ago the “average” ROA for a public system was certainly in excess of 7.5% (today it is estimated at 7.25%). Have hedge funds kept pace?

According to HFRI’s Hedge Fund Composite, the universe of hedge fund managers has produced a 3.6% annualized return for the 7 years ending June 30, 2018. If you go back 10 years, that return is only 3.5%. If you go all the way back 20 years, which would include two significant bear market environments, this collection of funds has produced a 4% return. Fairly consistent, but certainly anemic.

If you think that maybe the HFRI data has some quirks associated with it, the Credit Suisse and Barclay hedge fund composites produced 7-year returns of 3.6% and 4.5% respectively, while 10-year returns came in at 3.2% and 4.3%, respectively. Still ugly!

One saving grace is the fact that these are net returns. Unfortunately, the only thing that has been “hedged” during this period of time is return, as much of the reallocated capital flowed from traditional equity exposures. Oh, and the S&P 500 for the 7- and 10-year periods produced 13.2% and 10.2% annualized returns.

It is time to stop focusing on the ROA as the plan’s objective.  Managing a pension system is about meeting the promise at the lowest cost and not the highest return. Trying to “guess” how markets will perform and correlate with one another is a fool’s game. This approach hasn’t worked and it won’t work going forward. Manage your plan against your liabilities, especially the retired lives, which are known and manageable!

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