CalPERS is cutting its hedge fund allocation, particularly funds of funds.

California Public Employees’ Retirement System is taking the ax to its $5.3 billion hedge fund portfolio, with a goal of halving its allocation by September, Pensions & Investments reported this week.

The $290 billion pension fund’s private equity program, already the subject of cuts, also faces reductions, P&I said.

CalPERS, which has been investing in hedge funds for nearly a quarter century, is cutting back its allocation even as the hedge fund program is under review with no decision about its future expected until the third quarter, P&I reported.

P&I based its story on multiple, unnamed sources who, the newspaper said, were familiar with the pension plan’s operations. Neither Curtis Ishii, a senior investment officer for fixed income who is conducting the hedge fund program review, nor Egidio Robertiello, CalPERS’ senior portfolio manager for absolute-return strategies, responded to requests for comment, P&I said.

Sources told P&I that the CalPERS investment committee had learned of the reduction during March and April, and that its 13 hedge fund managers were told in the past several weeks. Three hedge fund managers are to be terminated, and the remaining 10 will see their allocations cut.

By September, the sources said, the hedge fund program will be reduced to around $2.5 billion.

As well, the hedge fund-of-funds program is being reduced to two funds from five, according to the sources. Robertiello had already terminated four other hedge fund-of-funds managers during his nearly two years at CalPERS.

The fund-of-funds segment, which has been a particular drag on performance, eventually will be cut to 15% to 20% of the portfolio from about 30%, the sources said.

Shift of Focus

P&I was unable to uncover why Ishii had decided to reduce allocations while the program review was under way. The hedge fund program had underperformed in the past, but was improving under Robertiello, it said.

The hedge fund portfolio returned 9.2% for the year ended Dec. 31, compared with the CalPERS custom hedge fund benchmark of 5.3%, according to CalPERS statistics. The custom benchmark is the one-year U.S. Treasury note plus 5%.

For the three-year period, the hedge fund portfolio returned an annualized 3.3%. vs. 5.4% for the benchmark. For five years, the portfolio returned an annualized 6.2% and the benchmark 5.6%.

The hedge fund program over the 10 years ended Dec. 31 returned an annualized 4.9%, compared with the benchmark’s 7.3% return.

Sources told P&I that Ishii was appointed to review the hedge fund program by acting CIO Theodore Eliopoulos in early January, just after Eliopoulos took over for Joseph Dear, who was ill at the time and died on Feb. 26.

Robertiello, who had reported directly to Dear, began reporting to Ishii around the same time.

Dear had supported an expansion of the hedge fund program, but Ishii was a key opponent of the program, according to P&I. It said Ishii was on the record as wanting to scrap the program, saying the risk of investment losses was too great.

Sources said Ishii had dominated semimonthly, closed-door review meetings since February, and repeatedly attacked the hedge fund program. They told P&I Ishii had said he planned to take about $2.5 billion from the hedge fund program and redirect it to fixed income.

Private Equity Cuts

A lack of quality investment opportunities may result in further reductions in CalPERS’ $31.1 billion private equity program, which is already the subject of cuts, P&I reported, citing an agenda item expected to be approved by the investment committee on May 19.

The latest move will reduce the pension fund’s target allocation to 10% as of July 1, from the current 14% target allocation.

The reduction to 10% was already planned, P&I reported, but under a new plan, an automatic phase-in program that was to increase the private equity target to 12% by July 1, 2016, will no longer occur.

Material from the April investment committee meeting showed that CalPERS would have had to commit $10.5 billion in new private equity investments overall in the next three years to have met the 12% private equity allocation by 2016, according to P&I.

CalPERS consultant Wilshire Associates reported to the investment committee in April that the investment staff’s own model had shown that “it would be virtually impossible” to reach the 12% target within two years without significantly compromising the guidelines for quality private equity investments, P&I reported.

P&I said that the board agenda material showed that CalPERS investment staff agreed with Wilshire as did CalPERS’ alternatives consultant Pension Consulting Alliance.

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