Large corporate pension funds significantly increased their investments in hedge funds over the past five years, according to the Wall Street Journal based on the latest analysis conducted by Wilshire Consulting on 300 companies listed in the S&P 500.
The report indicated that the returns of the pension funds underperformed the broader stock market in four out of the five previous years. In 2014 alone, pension funds recorded 9.7% returns (including dividends) compared with the 13.7% of the S&P 500.
Pension funds with the largest investment in hedge funds
The Wall Street Journal noted that the corporate and private-sector pension funds started increasing their bets on hedge funds since the financial crisis in 2008. Private-sector pension funds recorded huge losses from their investments in stocks during the crisis.
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Currently, private pension funds account nearly $1.00 of every $5.00 invested by institutional investors worldwide in hedge funds —the second largest behind public pension funds, according to Preqin.
The pension funds of Ford and United Parcel Service have the largest investment allocations in hedge funds at $4.4 billion and $3.6 billion, respectively. Most pension fund managers invested heavily in bonds and hedge funds to protect their assets against future recessions.
Since the financial markets, the central banks around the world implemented aggressive stimulus to support economic growth, which resulted to a multi-year rally in the equity markets. Pension fund managers who shifted investments from equities to hedge funds and other strategies skipped gains.
Data from Wilshire Consulting showed that corporate pension funds total equity portfolios declined from 54.1% in 2009 to 44.7% in 2014; total fixed income increased from 34% to 40.8%, and hedge funds climbed from 0.8% to 3.2%.
Jim McKeen, head of the hedge fund research at Callan Associates commented, “There’s certainly regret. The last five years have been disappointing for pensions invested in hedge funds.”
Pension fund managers defend investment in hedge funds
Hedge funds have a record of good performance in the volatile markets. Most of the prominent hedge fund managers deliver consistent high returns. Hedge funds are normally open only to rich investors and institutional investors.
Pension fund managers defended their move to invest more in hedge funds. According to them, their primary objective is to prevent potential losses. They also emphasized that corporate pension funds are not experiencing funding gaps similar to the size confronting public pension funds.
They explained that the largest companies in the United States were no longer providing defined-benefit plans to active or new employees. Such move made the future costs for retirement benefits fixed.
Ford Motor Treasurer Neil Schloss said, “It’s not outsize returns. That’s not the reason we invest in hedge funds.” He pointed out that hedge funds have been “a stable asset class.” The automakers’ $70.5 billion pension plan is almost 90% funded.
On the other hand, Intel’s primary reason for increasing its hedge fund investments is to meet its modest return targets over the long-term, particularly during periods when bonds and stocks deliver weak returns.
Intel invested 17% or $2.6 billion of its pension fund assets on a “healthy mix” of hedge funds. Its annual return target is 5%, according to Stuart Odell, assistant treasurer for retirement investments at Intel.
“It is hard to conclude that hedge funds as an asset class are riskier. Hedge funds consist of many different types of strategies,” said Odell. He noted that the stock price of some mutual funds declined more than 50% during the financial crisis.
Is it fair to blame hedge funds for the weak performance of pension funds? Some people think so as they compare the overall returns of large corporate pension funds with the S&P 500 in 2014.
Such conclusion seemed not logical since most pension funds invest a small portion of their total assets in hedge funds. However, there are some that acquired huge stakes in hedge funds such as Weyerhaeuser (57%) and CNA Financial (47%), which was described by the WSJ as “highly unusual elsewhere.”
Take note that large corporate pension funds such as Ford Motor emphasized that they invest in hedge funds, not for big returns, instead for protection from another economic downturn.
Robert Krakowiak, Treasurer at Visteon, an auto-parts supplier with 15% of pension fund assets invested in hedge funds pointed out,“We use hedge funds as defense.” He added that they are willing to sacrifice big returns to protect the pension fund from the impact of economic crisis.