James Says Use Buyouts to Shoot Lights, Not Hedge Funds

Blackstone Group LP President Tony James said the decision by the $298 billion California Public Employees’ Retirement System to exit its hedge-fund investments was “wise” because the pension had “poor” returns on the $4 billion it invested in the asset class.

“A lot of people think about hedge funds as a way to get higher returns,” James said today at the PartnerConnect LP-GP Summit in New York. “Hedge funds are a way to play the stock market with somewhat lower volatility and somewhat lower returns. You don’t expect hedge funds to get shoot-the-lights-out returns. You save that for private equity and for real estate.”

Calpers, the biggest U.S. retirement plan, was one of the earliest public investors in hedge funds, hiring New York-based Blackstone in 2001 to help the pension fund allocate an initial $1 billion to the asset class. Calpers this week said it will pull its entire $4 billion in hedge-fund investments after officials concluded the program couldn’t be expanded enough to justify the costs. The fund produced a 4.8 percent annualized return on its hedge-fund investments over the past 10 years.

The hedge-fund allocation was “not big enough to move the needle for them but big enough to require real resources,” Neil Chriss, the founder of hedge-fund firm Hutchin Hill Capital LP, said in a Bloomberg Television interview today. “So it made sense they were going to take it to zero or grow it significantly. Of course we worry, but what it tells us is we have to continue to offer differentiated returns.”

Blackstone Relationship

Blackstone, which manages $279 billion in alternative investments such as private equity, real estate and credit assets, is the largest allocator to hedge funds, with $61 billion in the asset class as of June 30. James joined the firm in 2002 to work under co-founder Steve Schwarzman.

Calpers has had a long relationship with Blackstone, which was founded in 1985 by Schwarzman and Peter G. Peterson. The pension fund had committed more than $2.5 billion in Blackstone’s buyout and credit funds as of March 31.

While still a relatively small part of pension funds’ investments, hedge funds have been receiving a growing share of money from retirement plans. Pensions with more than $5 billion in assets had an average of 1.35 percent in hedge funds as of June, up from 0.85 percent in 2008, according to Wilshire Trust Universe Comparison Service, a unit of consulting firm Wilshire Associates based in Santa Monica, California.

Public retirement plans with $1 billion or more in assets generated a 5.1 percent annualized return from its hedge-fund investments in the three years ended June 30, according to Wilshire Trust Universe. That compares with a 5.3 percent return from fixed-income holdings in the period, 11.5 percent from private-equity investments and 12.7 percent from stocks, the firm said.

Hedge funds, which are mainly for large investors able to assess and bear the associated risk, employ strategies such as betting on rising as well as falling asset prices, in an effort to gain even when markets stumble. They typically charge fees equal to 2 percent of the money they manage and keep 20 percent of any investment profits.

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