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US-Based Public Pension Funds: Major Source of Capital for Hedge Funds – September 2015

by Michael Brown

  • 09 Sep 2015
  • HF

Despite having entered the hedge fund space later, on average, than endowment plans and foundations, US-based public pension funds have become significant investors in the hedge fund universe. They are major allocators of capital to the hedge fund industry, accounting for approximately 16% of the total institutional capital allocated to the asset class.

Even the withdrawal from hedge funds of certain high profile US-based public pension funds such as California Public Employee’s Retirement System (CalPERS) in 2014 does not appear to have had a negative impact on the influx of these investors to the asset class. In fact, it appears these investors have been increasing in number since last year, when Preqin’s Hedge Fund Investor Profiles tracked 269 US-based public pensions compared to a total of 283 which are currently active in the hedge fund space.

Moreover, these investors have generally been showing strong levels of continued commitment to hedge funds. This is reflected by the year-on-year increase in their mean hedge fund allocations over the past five years, increasing from 7.2% at the end of 2010 through to 8.8% at present.

In terms of structural preferences, 52% of US-based public pension funds will consider investment only in fund of hedge funds vehicles, while 20% of these institutions prefer to go through a direct route of investment. However, it is likely that we will see a growing number of investors moving away from funds of hedge funds as a structural preference over the coming years as they acquire more experience in the asset class and expertise in manager selection.

There are a variety of hedge fund strategies sought by US-based public pension funds, with long/short equity strategies being the most widely selected within investors’ strategy preferences, sought by 54% of these investors. The relatively higher liquidity of multi-strategy (48%) and macro (44%) funds compared to equity strategies also appeal to US public pensions with event driven (41%) and long/short credit (36%) also considered by a notable proportion of these investors.

While the majority of US-based public pension funds invest globally in the hedge fund space, 90% specifically cite North America among their geographical preferences. A third of these investors specifically consider Europe and 32% opt for investment in the emerging markets.

Despite some high profile public pensions such as CalPERS electing to move out of hedge funds over the last 12 months, appetite for hedge funds remains strong among this group of investors. Preqin data shows that the number of US public pension funds entering the hedge fund asset class has been increasing over the past several years with many demonstrating a willingness to raise their hedge fund allocations in an effort to reduce risk and volatility in their overall investment portfolios. If these trends continue US-based public pension funds will be a major source of institutional capital in the hedge fund industry for years to come.

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