Much is being made this morning about the news that the country’s largest pension fund, Calpers, is eliminating their investments in hedge funds and hedge fund of funds. Calpers was diplomatic in its announcement (via WSJ):

“Hedge funds are certainly a viable strategy for some,” said Ted Eliopoulos, interim chief investment officer at Calpers, in a statement. For Calpers, the program “doesn’t merit a continued role” due to how complex and costly the funds can be, he said.

This change, $4 billion of nearly $300 billion in assets, is for the fund a small one but is being taken by many as a sea change for the hedge fund industry. Make no mistake hedge funds are now in fact an industry. Barclay Hedge shows hedge funds managing some $2.8 trillion in assets as of Q2 2014. These funds generate huge fees for their managers and for the firms that support them. It is not for nothing the highest paid hedge fund managers often earn in the billions per annum.

The question is whether Calpers is the beginning of the end of the institutional asset gravy train for hedge funds or just a blip along the way?

Barry Ritholtz at Bloomberg View has been writing about the shortcomings of hedge funds thinks this could be start of a bigger trend:

What does this do to the belief that hedge funds delivery higher returns than equities? This expectation, of course, has proven to be a myth. But state treasurers bought into this fiction because it allowed them to make much smaller contributions to employee-retirement accounts, keeping local tax rates down. This short-term patch is setting up much bigger shortfalls in the future.

Cullen Roche at Pragmatic Capitalism thinks that this move is another blow to high fee structures all over investment management:

More interestingly, this is another big blow to high fee fund managers.  The days of being able to charge 2 & 20 are dying out.  My general guidance on any form of active management is to avoid any fund with a fee structure over 0.5%.  I make an exception on rare occasion for higher fee funds, but that’s a pretty good rule of thumb in most cases.  And that’s on the high side….

Dan McCrum at FT Alphaville notes both the cost and complexity argument. However he makes another point that is applicable to large funds like Calpers. His point is that building a sizable hedge fund portfolio that is able to outperform without undue risk (and correlation) is difficult at best:

What is difficult to the point of impossible when most hedge funds fail (the average life of a fund is just five years) is selecting a collection of hedge funds that deliver on the sales pitch… that are also suitable for pension funds to invest in. Young and very small hedge funds may offer good investment returns, but a pension fund can’t spot them in time, or invest in a size which makes it worthwhile.

Even before this announcement the hedge fund fee structure was coming under attack. Klaus Wille at Bloomberg notes how high standard fees sap performance in a low nominal return world.

The fees, which still make up as much as 2 percent of a fund’s assets, represent a disproportionately high share of the total remuneration unrelated to performance, said Nicolas Rousselet, head of hedge funds at Unigestion. To align managers’ pay more with performance, the fund industry should either abandon the management fee or combine it with a hurdle rate that one must achieve before collecting incentive fees, he said.

One could argue that pension funds, as opposed to endowment funds, are a poor home for hedge funds. Either way there are a shrinking number of people willing to defend hedge funds. That being said hedge funds aren’t going away any time soon. As long as there is a desire on the part of investors to outperform the market there will be a ready source of asset for hedge fund managers. It may simply be the case that the biggest hedge funds continue to get bigger.