Extreme topiary

Hedge fund-free - the latest Californian fad?

Call it the Sacramento Model. In contrast to the famed Yale Model for endowments, Calpers, the $300 billion Californian pension manager, is exiting its $4 billion of hedge fund investments. For retirement funds, Calpers' hedge-fund free regime could be more than the latest fad from the Golden State.

Part of the problem is performance. Though the sector now manages an all-time high $2.8 trillion worth of assets, according to Hedge Fund Research, returns are uninspiring. The typical manager is up only four per cent this year, less than the 10 per cent total return on stocks in the S&P 500 Index. Even a Barclays index of boring government bonds has returned five per cent.

Last year, the nine per cent result for the typical hedge fund holding beat a small loss for bonds, but paled next to the 32 per cent total return on the S&P 500.

That wouldn't seem quite so lame were it not for the high fees that hedge funds charge, typically two per cent of assets and 20 per cent of gains. Net returns may be what really matter, but publicly scrutinized and governance-conscious operations like the Sacramento-based Calpers have to take costs into account, something the fund underlined in new principles instituted in September 2013.

Moreover, the pension fund's managers were not fully convinced that hedge funds deliver the absolute returns at a reasonable cost that they promise. Too many look like expensive stock pickers, with the risk of illiquidity thrown in. Without conviction, Calpers' couldn't expand its holdings sufficiently for hedge funds to have enough impact its performance.

That's where endowments like Yale University's, where David Swensen pioneered hefty exposures to alternative assets like hedge funds, may differ. A very long term, even perpetual investment horizon - and an absence of the huge predetermined cash outflows that burden pension funds - make illiquid investments a much less risky proposition.

Plenty of public-sector pension funds still invest in hedge funds, including some in New York City and the highly regarded Ontario Teachers' Pension Plan. But when the largest in the United States decides not to, others will be forced to think hard. Calpers could be setting a trend.