Last week, CalPERS, the California Public Employees’ Retirement System, which manages approximately $300 billion on behalf of 1.6 million public school and other local and state employees, announced that they “will eliminate its hedge fund program, known internally as the Absolute Return Strategies (ARS) program, as part of an ongoing effort to reduce complexity and costs in its investment program”. The press release went on to say that as part of the elimination of the program, the fund will drop 24 hedge funds and six hedge fund-of-funds valued at approximately $4 billion.

The lesson here is that the complex strategies offered to institutions and, increasingly, to individual investors through hedge funds don’t deliver the returns necessary to justify the fees charged. Typical fee arrangements for hedge funds include an annual 2% management fee based on assets under management in addition to 20% of the profits (usually above a benchmark).

In CalPERS latest preliminary investment performance report for the fiscal year ending in June 30th 2014, the ARS program returned 7.1% compared to 24.8% for their global equity allocation and 18.4% for the overall portfolio. By way of additional comparison, the Vanguard Balanced Index Fund, a portfolio similar to the typical strategic asset allocation for pension funds with 60% US stocks and 40% US bonds, returned 16.39% over the same period. Despite the exotic strategies employed by CalPERS’ hedge fund investments, they failed to outperform the remarkably simple Vanguard fund.

High fees, complexity, illiquidity and for private investors, tax inefficiency are all reasons to avoid hedge funds at all costs.

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