The hedge fund industry averaged a mere 4.6% p.a. return in the 10 years ending June 30, 2020, equaling just over a third of the S&P500 benchmark which averaged 12.5% p.a., according to Global SWF’s latest newsletter.

The comparatively low returns of hedge fund programs combined with their excessively high management and incentive fees has seen the average pension fund allocation fall from 1.7% to 1.2% since 2015 — with several prominent sovereign investors including CalPERS and ISBI making their exit completely.

Keeping the faith, however, is the Canada Pension Plan Investment Board (CPPIB), the largest Canadian pension fund, which manages $419 billion in assets of which 5% ($22.7 billion) is currently allocated to hedge funds.

Priti Singh,
CPPIB

The pension fund has a long-term capital allocation and deployment plan which generates desired allocations based on capital and “risk/return assumptions” of various asset classes and strategies, said Priti Singh the managing director, global leadership team, head of external portfolio management at CPPIB.

“Our allocation to external hedge fund managers has held steady at around 10% of plan assets,” Singh told AsianInvestor.

“Our plans to increase or decrease would depend on the opportunity set,” she said.

CPPIB has the highest allocation of any public pension fund (PPF) and ranks fourth highest overall among all state-owned investors. Other major Canadian pension funds OTPP and CDPQ — which allocated 6% ($11.5 billion) and 3% ($9.7 billion) of their AuM respectively — also feature in the top 10 of state-owned investors (SOIs) in hedge funds but declined to offer comment.

SWFs ALLOCATION RISES

Despite the trend of pension funds decreasing their investment, sovereign wealth funds (SWFs) have been steadily increasing their allocations in hedge funds which has risen from 1.0% in 2008 to 1.8% in 2021, according to Global SWF data.

Diego López,
Global SWF

“SWFs are by nature less risk-averse and less accountable than PPFs, given the lack of explicit liabilities and specific horizon - so their bet on a risky asset class such as hedge funds makes sense,” Diego López, managing director at Global SWF told AsianInvestor.

Approximately $186 billion is invested into hedge funds by SWFs with the largest allocators ADIA, CIC and Future Fund representing two thirds of this capital.

Among the top 25 hedge fund investors are also eight US endowment funds. Harvard tops the list with a third ($17.6 billion) of its $53 billion in AuM invested, followed by UTIMCO with a $7.6 billion portfolio allocation and Yale which has allocated $6.7 billion of its $31 billion portfolio in hedge funds.

MARKET RISK SENTIMENT SHIFTS LOWER

It is difficult to predict what the future holds for hedge fund investing. Global SWF reports that most asset owners appear to agree that the private markets present greater performance potential for the next few years, and there does not seem to be any consensus from SOIs about the benefits of having part of the portfolio invested in hedge funds.

Globally, investors are feeling less comfortable with the risk of hedge funds as their concerns grow over rising inflation driven by supply chain bottlenecks and the developing energy crisis in Europe and China, according to independent data provider Eurekahedge.

When asset owners decide how much capital to allocate to a hedge fund they focus on the potential returns, the funds alignment with their investment horizon and, especially, management costs.

Equal-weighted and asset-weighted hedge fund performance

As hedge fund performance continues to trend down, the risk may soon outweigh the potential rewards for all SOIs.

“The returns of hedge funds has been disappointing when compared with other asset classes in the past 10 years. Together with the high costs, it could mean more LPs dropping off their hedge fund programs in the future,” said López.