Pension Funds are Loading Up on Hedge Funds

US Pension funds are starved for returns, and they are loading up on Hedge Funds.

"While most pension plans have modest stakes in hedge funds, others have invested more than 20 percent of their assets. Weyerhaeuser, the paper company, has 39 percent of its pension fund's assets in hedge funds. In Congress, there has been a push for amendments that would make it easier for hedge funds to manage even more pension money, without having to comply with the federal law that governs company pensions.

... Pension officials who have been shaken by market downturns and persistent deficits are attracted by hedge funds' promise of richer, or more consistent, returns. But the trend has caused some consultants and academics to voice cautions. They question whether hedge funds, with risks that are hard to measure, are appropriate for pension funds, whose sole purpose, by law, is to pay out predetermined benefits to retired workers."

Whoa! Having worked at a small Hedge Fund, they do fill a need in terms of providing exposure to financial instruments and strategies, that tend to be uncorrelated to what are found in a typical portfolio. Traditionally, they target high net-worth individuals, and sophisticated investors usually allocate 1-10% of their portfolio to Hedge Funds. But 39%, or even 20%???? Hedge Funds and other alternative investments may have a place in the portfolios of those who can afford them, but they are meant to smooth out returns. To rely on them as the main source of returns is not a good long-term strategy for a Pension Fund.

The scary thing is that there is a Hedge Fund bubble right now: thousands of funds with NO extended track record are open to new investors. A recent paper by Andrew Lo and his MIT colleagues gives a good summary of the current state of the Hedge Fund World. Among their conclusions:

"Our preliminary findings suggest that the hedge-fund industry may be headed into a challenging period of lower expected returns, and that systemic risk is currently on the rise."

A short background on why Pension Funds are desperate for higher returns: The US Pension Benefit Guaranty Corp, the pension equivalent of the FDIC, reported a $23B deficit, and the risk of a goverment bailout is rising. With the need to fund pensions for thousands of retirees, companies like GM are finding themselves at a competitive disadvantage.