Stocks and bonds have been pummeled this year. But bets on hedge funds have paid off for the giant Teacher Retirement System of Texas.
The roughly $184bn pension fund, one of the biggest in the US and a significant investor in hedge funds, lost 2.3% for the fiscal year ended June 30, outpacing the median 5.1% loss for large pension funds reported by Wilshire Trust Universe Comparison Service. Its $9.7bn portfolio of so-called stable-value hedge funds — which includes funds run by Man Group, Systematica Investments and Citadel that are intended to zig when markets zag — gained 9.4% for the period.
Texas Teachers’ also invests $6.6bn in what it calls “directional hedge funds” intended to more closely track stock markets. That portfolio lost 6.6% for the year ended June 30, bringing the pension’s overall hedge-fund return to slightly more than 2%, according to an estimate by The Wall Street Journal — in a year when major stocks and bond indexes have registered double-digit losses.
“For a decade, stocks and bonds have had high returns so the usefulness of hedge funds to portfolios has been low,” said Dale West, senior managing director of public markets for Texas Teachers’. “But when you have a year like this, the fact that hedge funds are sort of steady in the background — you really see the value of that.”
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Texas Teachers’ earned annualised five-year returns of 6.7% and 5.6% on its stable-value and directional hedge-fund portfolios as of June 30, compared with 8.1% for the trust as a whole. Texas Teachers’ doesn’t report an overall hedge-fund return.
Hedge funds have been in a yearslong slump, on average trailing the total return of a traditional portfolio made up of 60% global stocks and 40% US bonds in nine out of the last 10 years ended 2021, according to data from research firm HFR and Dow Jones Market Data. Bright spots included biotech funds and stock-picking funds focused on fast-growing companies, both strategies that have reversed this year. But investors who remained invested in a range of hedge-fund strategies are now reaping the rewards.
“The large percentage of hedge funds have done extraordinary this year relative to stocks and bonds,” said Greg Dowling of Cincinnati, Ohio-based investment consulting firm Fund Evaluation Group. He cited as examples macro funds, which try to anticipate big-picture market movers like the direction of interest rates, and equity-market-neutral strategies, where a fund’s long exposure to the market is offset by its short wagers. “You’re seeing the benefits of broad diversification” beyond stocks and bonds in portfolios, he said.
West said the pension’s hedge-fund investments added value by providing returns uncorrelated to stock markets. He also said hedge funds were proving valuable by providing cash from redemptions at a time when generating liquidity from investments at anything other than depressed prices has been difficult.
The pension redeemed roughly $1.4bn from hedge funds in calendar year 2022. It expects some $500m in cash in January from year-end hedge-fund redemptions. The redemptions, mainly aimed at keeping hedge funds to about 10% of the pension’s portfolio as other assets lost value, covered many retired teachers’ pension checks.
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Hedge funds’ mixed performance over a period encompassing part of a historic bull run pushed some US pensions to pull back from hedge funds over the past five years, including moving more heavily into private equity or shifting into lower-cost strategies. Average allocations to hedge funds by large US public pensions fell from a high of 8% in 2017 and 2018 to 5% in 2021, the most recent year data was available from the Boston College Center for Retirement Research.
Texas Teachers’ has carved a different path. The pension’s hedge-fund portfolio has grown fairly steadily since its creation in 2000. It had $16.3bn in hedge funds as of the end of June, or about 9% of the portfolio, just under a 10% state cap.
Board members voiced doubt about the retirement plan’s hedge-fund investments over the years, according to meeting minutes. That includes discussing a 2014 plan by the massive California Public Employees’ Retirement System to phase out its hedge-fund portfolio, and questioning whether Texas Teachers’ was paying high fees only to trail passive benchmarks.
West in a 2017 board meeting said that hedge funds’ performance for the prior five years hadn’t contributed significantly to the pension but that pushing fund managers to move away from traditionally expensive fee structures would lead to greater benefits. Texas Teachers’ push for lower fees, along with its 2012 deal to buy a minority stake in Bridgewater Associates, attracted attention in the hedge-fund industry.
In a recent interview, West said the majority of the pension’s hedge-fund managers have moved to alternative-fee structures. He also said hedge funds looked attractive, given investors’ expectations for ongoing volatility and the potential gains from funds specialising in trading distressed debt if the economy slows.
For its fiscal year ended Aug. 31, the pension lost 6.7%. Those losses are greater than the June 30 return because the August figure doesn’t include strong gains in July and August 2021. The Journal used the pension’s June 30 returns to facilitate peer comparisons.
Write to Juliet Chung at Juliet.Chung@wsj.com and Heather Gillers at firstname.lastname@example.org
This article was published by The Wall Street Journal, part of Dow Jones