Back in September, CalPERS (California Public Employees’ Retirement System) the country’s largest public pension fund decided to pull out of all hedge fund investments. The reason: fees are too high to justify the returns generated. The decision has some hedge fund managers worried, and others crying. Although CalPERS had only allocated about $4 billion to direct hedge fund investments, the fund is considered a bellwether for other public pension funds and endowments. At about $300 billion of total assets under management, when CalPERS talks, people listen.
One of the people listening was Paul Singer, head of hedge fund Elliot Management. In a recent letter to investors, Paul threw a bit of a tantrum about CalPERS decision and sounded like a cry-baby toddler when his friend takes the toys and goes home. Singer called the CalPERS decision “off base” and betrayed his lack of understanding of fiduciary duty for public funds saying “We… never understood the discussions framed around full transparency. While nobody wants to invest in a black box, Elliott (and other funds) trade positions that could be harmed by public knowledge of their size, short-term direction or even their identity.”
Typical of many money managers, Singer takes money from other people, then feels it’s his God-given right to manage that capital however he wants, and somehow thinks he has no duty to disclose what he’s doing with it. He makes a good argument from a self preservation point of view. If other funds figure out his secret sauce, then he’s got no “edge” (a term well-worn at SAC Capital, as this article details). But CalPERS, taking its fiduciary duties seriously, wants to know where the money it has given managers goes once it’s invested.
Additionally, the most astute investors know that cost matters about as much as returns when it comes to their investments. Ted Eliopoulos, interim Chief Investment Officer at CalPERS said, “One of our fundamental investment principles is that cost matters” and hedge funds are “an expensive investment vehicle, especially at our scale”.
In response to that concern, Singer again whines in his letter: “We at Elliott do not understand manager selection criteria based on the level of fees rather than on the result that investors could reasonably expect after fees and expenses are taken into account.” Apparently there are a few things Singer just “doesn’t understand”. Investors are concerned about fees because they eat into returns, often times materially. What’s more, fees and expenses are constant and known, whereas returns are volatile and unknown. It’s a bit disingenuous for Singer to ask investors to contemplate fees only after “the result that investors could reasonably expect”. It hardly matters what you expect results to be, they are unknown and unpredictable until they happen.
Just ask Marathon Asset Management, or Claren Road Asset Management what returns they expected before October delivered its volatility surprise (the two debt funds had their year-to-date returns wiped out in the first two weeks of October). Claren Road lost 9.7% last month, and is headed for its first losing year since it was founded in 2005. Would Mssr. Singer suggest investors should have reasonably expected that result, and be willing to pay for it? On the contrary, investors tend not to like nasty surprises. Reports indicate that Claren Road has suffered $1.9 billion of redemption requests as a result. That’s more than 25% of the fund’s assets under management. Talk about “taking a hit”…
Investors generally, and money managers in particular, would do well to read and learn from Charles D. Ellis’s recent FAJ article on the rise and fall of performance investing, linked here. As Ellis points out though, it will be a long time before performance managers accept the fact that they just don’t deliver returns that justify their fees.