While the hedge fund industry is already considered very competitive, the situation could intensify after the California Public Employees’ Retirement System announced it will eliminate its entire stake in these buy-side firms.
In addition to this competition, hedge funds are facing IT pressures, including rising costs for benchmark data and greater demands from clients to use a wider range of benchmarks, as well as ones that are customized. These developments are pushing the expenses of these buy-side firms higher at a time when their inflows could be threatened.
Institutions could flee hedge funds
Hedge funds had $2.81 billion in assets under management at the end of the second quarter, according to BarclayHedge data reported on by USA Today. However, the recent move by CALPERS, the largest U.S. pension fund, could motivate investors to start pulling their resources from these buy-side firms.
The California State Teachers’ Retirement System, the second-largest pension fund in the U.S., recently tried its hand at investing in hedge funds, but after generating meager returns, will evaluate this decision at the end of 2014, according to The Wall Street Journal. Previously, the pension fund invested $700 million into these buy-side firms for a period of three years.
While the investments in the hedge fund produced a 0.13 percent return in the last year, a spokesman for the teachers’ fund said that this financial performance is one of several factors the investment committee will consider when determining its strategy going forward.
Hedge funds performance lagging
Hedge funds as a whole have failed to outperform various measures of stock market performance, according to USA Today. The average fund performance was 10.3 percent in 2013, whereas the S&P 500 produced a total return of 32.4 percent, according to eVestment figures. This difference continued in 2014, as the S&P 500 generated a total return of 9.88 percent through August and hedge fund performance was 3.96 percent.
One factor fueling this subpar hedge fund performance was that in the beginning of August, the exposure these buy-side firms had to stocks hit its lowest in the past two years, the media outlet reported. Instead of simply purchasing equities like a more vanilla mutual fund, a hedge fund might engage in long-short strategies, currency trading or buy undervalued assets.
In an increasingly competitive environment, evaluating the results of these complicated strategies will require hedge funds to rely on benchmarks more frequently. As a result of this situation, these institutions need to ensure high standards for data integrity.