November 12, 2004

CalPERS Considers Doubling Hedge Fund Bet

SACRAMENTO, Calif. (HedgeWorld.com)--Having ramped up its hedge fund investment total to almost US$1 billion in recent months, the California Public Employees' Retirement System is now proposing to double its allocation to hedge funds.

Through the end of September, the pension system had committed more than US$925 million to hedge funds. By year-end, hedge fund assets will likely reach US$1 billion as CalPERS officials scrutinize two additional funds that would be brought into the stable, according to investment committee documents.

The timeline for the plan to move another US$1 billion into hedge funds, currently laid out as a staff proposal, is unspecified.

In further advancing its position as the largest pension fund allocation to hedge funds, CalPERS must contend with cautionary advice from one of its consultants, Wilshire Associates. The Santa Monica, Calif.-based firm some worries over the new allocation in a memo to Mark Anson.

"While Wilshire supports the Staff's efforts to date with hedge funds, Wilshire has some concerns about the current hedge fund market environment that we believe should be considered in the face of the new $1 billion allocation recommendation," Michael Schlachter, managing director of Wilshire wrote.

The US$165 billion pension fund's investment committee is set to approve the staff proposal on Monday.

Wilshire's concerns center on large recent inflows into hedge funds and dimmer return expectations for hedge funds than in the past. Earlier this year, Wilshire Senior Managing Director Mike Napoli expressed concerns over the issue of capacity and its ultimate impact on funds of hedge funds (see ).

In his memo, Mr. Schlachter said that Wilshire's support of an additional hedge allocation would be contingent on the CalPERS staff's commitment to a "patient" timeframe, similar to how the largest U.S. pension fund invested the first US$1 billion over the course of four years.

Besides making direct investments in hedge funds, as officials have traditionally done, CalPERS' staffers want to allocate up to US$500 million of the new mandate to a select group of hedge funds of funds. Each fund of hedge funds would have to construct a customized portfolio with risk and return distribution characteristics that will complement the CalPERS internal portfolio. Single-fund investments made by CalPERS would total 75% of its internal portfolio, while funds of funds would account for the remaining 25% of the total US$2 billion mandate.

Hedge fund administrator International Fund Services, New York, is reconciling monthly returns for the program and has established a risk-reporting platform along with CalPERS' staff.

In addition CalPERS will maintain its relationships with advisors Pacific Alternative Asset Management Company, Irvine, Calif., and Union Bank of Switzerland, New York.

PAAMCO remains a strategic adviser to the pension fund, providing investment objectives and designing a multi-strategy hedge fund portfolio, while UBS will make recommendations to the advisory board on hedge fund investments and conduct due diligence and monitoring.

In the meantime, Wilshire says in a memorandum sent to CalPERS that it will conduct an on-site due diligence visit with the system's hedge fund staff before year-end and will report its findings to the board "regarding the capabilities and resources of the CalPERS' hedge fund staff."

Contact Bob Keane with questions or comments at: bkeane@investmentadvisor.com.

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