Monday, August 27, 2007

Global Liquidity Continues to Fall; Public Pension Funds Reverse Decision to Allocate tens of billions to hedge funds

Public pension funds are the mother load of new assets for hedge funds. With corporate defined benefit pension plan assets slowly dwindling away and what remains of corporate pensions going into to 401k plans which cannot invest in HFs, and with endowments and foundations already fully allocated for the most part, publics have been THE BIG opportunity for HFs. Especially for the $10 billion hedge funds that want to become $50 or $100 billion "asset management firms".

Public pensions are notoriously slow off the mark but in recent years they've begun to notice that most other institutional investors, the world over, have 10, 20, 30% or more in hedge funds and private equity. And so the public funds set the wheels in motion (slow motion) to begin to invest. Now remember, these funds are elephants - large and slow. It can take them a year or more to make a decision, get approval, and then invest. And over the last year or so they have begun to put billions to work in HFs.
According to a Greenwich Associates report from this spring:

Institutional investment represents 25% of large hedge funds’ assets. Large hedge funds were defined as ones with over $1bn in assets. Institutional Investment comprised 20% of hedge fund assets in 2005, and 23% in 2006. Corporate pension investment in large hedge funds edged up to 8% in 2007 from 7% a year ago. Investment by endowments and foundations inched up to 11% from 10% in 2006. Public pension fund contributions rose to 6% from 5% last year.

Note that this understates the magnitude of institutional flows into HFs because HF of funds represents about 20% of all large HF assets and I would guess about half or more of HFoFs assets comes from institutions.

So, alas, the opportunity for HFs to tap into the public pension gold mine may be gone. The achilles heel of the publics has always been their sensitivity to volatility and especially their sensitivity to BAD PRESS. One Amaranth per year was probably not sufficient to cause the publics to reverse their plans but TEN AMARANTHS per MONTH certainly is. And that is whats happening. This is all very predictable. If you get paid nothing to take risk and if you get fired if anything you do is the least bit controversial and if you get shot if anything in your fund shows up in the papers, well, why do it? Unless the world becomes safe and happy and stable all of a sudden and the whole subprime mess fades away and the US economy chugs along happily - unless there are no more HF blowups... this could be it for public pension fund inflows into HFs.

The money quote (from today's WSJ) from Frederick Rowe, chairman of the Texas Pension Review Board, which provides oversight of Texas public pension funds:

It's like planning a vacation to an exotic land, and finding out that there's an outbreak of bubonic plague.

Bubonic plague indeed. Like rats from a sinking ship, eh?

And to put this into perspective, to remind ourselves of the implications, more HF assets means more liquidity because every dollar that goes into a HF gets levered by 3x or 10x or whatever. The decision by public pension plans NOT to invest in HFs or possibly even take money out means that global liquidity will be significantly less than it otherwise would have been.

No comments: