All That Glitters Is Not Gold - Action Center on Race and the Economy

Executive Summary

Hedge funds have aggressively pursued U.S. public pension dollars, maintaining that they offer pension funds absolute return and volatility reduction in exchange for the high management and performance fees that they charge. And many public pension systems, with encouragement from their investment consultants, have made significant allocations to hedge funds, chasing the promise of superior returns and downside protection. These pension funds now have sufficient experience to evaluate whether hedge funds have delivered on their promise, and whether the purported benefits are worth the high fees.

This report examines whether hedge funds have, in fact, provided U.S. pension funds better and less correlated returns, and whether hedge fund fees are adequately disclosed and as disproportionately high as critics suggest. In other words, we seek to answer the question: “Would public pension funds have fared better if they had never invested in hedge funds at all?”

To answer this question, we analyzed 11 U.S. public pension funds’ experience with investing pensioners’ savings in hedge funds. Using publicly available data and information provided directly by the pension funds, we conducted a simple year-by-year comparison of hedge fund net returns and total fund net returns for each pension fund. We also compared these rates of return with fixed income net returns for each pension fund to determine whether hedge funds delivered on the promise of uncorrelated returns and whether less expensive fixed income strategies do better. Because hedge fund fees are almost never reported or fully accounted for, we used industry standard fee structures like management and incentive fees, then projected actual fees captured by hedge fund managers based on readily available statements of net return to investors. These calculations, while not precise due to lack of transparency with respect to fees, allow us to draw general conclusions about the performance of pension funds’ hedge fund investments.

Key Findings: Hedge Funds Were Responsible for an Estimated $8 Billion in Lost Investment Revenue

Our findings suggest that these 11 pension funds’ hedge fund investments failed to deliver any significant benefits to the pension funds studied. Specifically, we found that:

  • Hedge fund net return rates lagged behind the total fund for nearly three-quarters of the total years reviewed, costing the group of pension funds an estimated $8 billion in lost investment revenue.
  • Despite lagging performance, hedge fund managers collected an estimated $7.1 billion in fees from the same pension funds over the period reviewed; on average, our estimates suggest that these pension funds paid 57 cents in fees to hedge fund managers for every dollar of net return to the pension fund.
  • Whereas hedge fund managers promise uncorrelated returns and downside protection, all of the 11 pension funds reviewed demonstrated significant correlation between hedge fund and total fund performance.


Considering the implications of these findings for pension fund trustees, participants and consultants, we recommend that public pension funds currently invested in hedge funds immediately take the following steps:

  • Conduct an asset allocation review to examine less costly and more effective diversification approaches. The review should include a complete analysis of past net performance of their hedge fund investments, as well as a comparison with low-fee alternatives.
  • Require full and public fee disclosure from hedge fund managers and consultants, including complete disclosure of historical investment management and incentive (carry or profit-sharing) fees captured by hedge fund managers for the duration of their fund’s investments. Pension funds should also consider developing legislative policies requiring this level of disclosure.