New Jersey Pensions Slash Hedge Fund Allocation For 2nd Time In 3 Years

Aside from a handful of notable outliers, 2018 was another bruising year for the 2-and-20 crowd, as average returns sunk deep into the red and LPs yanked money at the fastest pace in years.

The carnage was so bad, several venerable funds decided to return outside capital and pack it in, a sign that LPs had reached the limits of their patience with the so-called 'smart money' crowd.

Hedge Funds

Even some successful funds like David Tepper's Appaloosa Management decided to quit while they were ahead, opting to return capital to shareholders and convert to a family office.

After this historic beatdown, one would think desperate active managers would at least have had the good sense to BTFD. But amazingly, hedge funds continued to underperform during the Q1 rebound, even as US stocks experienced one of their strongest rebounds in decades. As managers struggled to attract new capital, new fund launches sunk to their lowest level since the start of the century.

After all of this, the last thing PMs needed was more bad news. But alas, that's what they got on Wednesday, when the New Jersey State Investment Council unanimously voted to cut its hedge fund allocation in half for the second time in three years, reducing investments in the sector to just $2 billion, Bloomberg reports.

That's a far cry from the more than $9 billion they had allocated as of May 2016.

Though the board didn't say which funds would be impacted, some of the firms it had money with as of last month included Winton Capital Management, MKP Capital Management, Solus Alternative Asset Management, Chatham Asset Management, Davidson Kempner Capital Management and Elliott Management.

New Jersey's labor unions pushed for the cuts, arguing that hedge funds wasted their members' money by collecting high fees while lagging market benchmarks - echoing the criticisms levied by New York City's pension for civil employees and CALPers three years ago when they cut ties with hedge funds, prompting firms to slash management fees amid fears that the industry could be headed for an extinction level event.

While praising the NJSIC's decision, one union spokesman hinted that more cuts could be in the offing.

"Several members had concerns about this over the last several years," said Eric Richard, one of the council’s union members. "I am happy to see us move in this direction." Richard, legislative affairs director for the New Jersey AFL-CIO, said he questioned whether the allocation to hedge funds provided effective downside protection, if the fees were justified and performance was comparable to peers.

Adding insult to injury, New Jersey's investment board also voted to increase its allocation to private equity funds. The changes will take effect in October.

The NJSIC managed $79.5 billion as of the end of last month. And during the five years to April 30, New Jersey’s credit-oriented hedge funds produced annualized gains of 3.1%, while its equity-oriented funds returned just 1.54%. That's compared with the Barclays US index, which returned 2.6% for the period, while the S&P 500 returned 11.6% with dividends reinvested.

If the current selloff metastasizes into a full-blown bear market, NJ's remaining funds might have an easier time meeting their benchmarks. But then again, this wouldn't be the first time that the advent of a 'stock picker's market' failed to materialize.