Calpers Absolute Return Strategies: Hedge Fund Risk and Return

Abstract

This case is suitable for students in both undergraduate and MBA-level investments courses. With an estimated $3 trillion in assets under management, hedge funds have become an important component of many institutional investors' portfolios. For many of these investors, investments in these funds are motivated by the potential for diversification combined with equity-like and bond-like risk. At the same time, the difficulty of appropriately benchmarking hedge fund returns and risk, in addition to the high fees associated with these funds, has some investors questioning their decision to invest in these strategies. Using CalPERS's April 2014 reexamination of its Absolute Return Strategies/hedge fund investments as a backdrop, this case examines the decision to invest in hedge funds as a part of a well-diversified institutional portfolio. Excerpt UVA-F-1735 Jun. 29, 2015 CalPERS Absolute Return Strategies: Hedge Fund Risk and Return The California Public Employees' Retirement System (CalPERS) headquarters near the Sacramento River was as beautiful as it was functional. With courtyards and terraces, beautiful landscaping, an architecturally stunning glass-and-steel entry pavilion, and a soaring glass atrium that flooded the building with natural light, it appeared to be as tranquil a work setting as the Zenlike spaces that dotted its interior and exterior. In the spring of 2014, however, internal sources suggested that a storm was brewing within the building over CalPERS's hedge fund investments. Two of CalPERS's most senior investment professionals, Curtis Ishii and Egidio “Ed” Robertiello, disagreed strongly about the future of these investments. Hedge funds had been a part of CalPERS's portfolio for 22 years, but there was a strong push by Ishii, the senior investment officer responsible for fixed income, to eliminate CalPERS's allocation to Absolute Return Strategies (ARS). In addition to the high fees CalPERS was paying to hedge fund managers, Ishii was convinced that hedge fund investments were an unacceptable risk for the pension fund. On the other hand, Robertiello, the senior portfolio manager for ARS, believed that the ARS allocation should be almost tripled. Robertiello argued that not only would an increased allocation to hedge funds help to diversify CalPERS's portfolio generally, but that hedge funds offered better downside protection than equities. . . .