The New Jersey Investment Council has voted to reduce its strategic allocation to hedge funds from 12.5% to 6% of the $71.9 billion portfolio.
“Our approach is strategic. It’s not throwing out the baby with the bath water.”The new mandate, approved unanimously at the fund’s August council meeting, cuts out all equity-focused hedge funds and most credit-based funds in favor of low-fee, risk-mitigating managers.
“We have come a long way in distinguishing the types of alternative investments that will serve us well and the types that won’t,” council Chairman Tom Byrne said at the meeting Wednesday.
The hedge fund cut follows more than a year of contention over the pension fund’s alternative investments. In June 2015, Byrne defended fees paid to alternative managers at a state senate oversight hearing following criticism by labor union AFL-CIO over the investments’ high costs.
The debate continued at January’s council meeting, when consultant Aon Hewitt presented the case for alternatives. The AFL-CIO followed up in March with its own consultant presentation, this time advocating for the return to a 60/40 portfolio of stocks and bonds.
The issue came to a boil in May, when the council was unable to approve an investment plan for 2017 prior to the start of the fiscal year due to disagreement over capping hedge fund investments at 4%.
The result Wednesday was a consensus plan allowing hedge fund investments to range from 0% to 10% of the portfolio and keeping the strategic allocation to risk-mitigating funds at 6%.
“Our approach is strategic,” said Byrne. “It’s not throwing out the baby with the bath water.”
“Public funds aren’t going to just pay whatever hedge funds are charging.”Christopher McDonough, director of the New Jersey Division of Investments, said keeping managers focused on risk mitigation would allow the program to achieve uncorrelated returns while retaining the downside protection that makes hedge funds valuable to the portfolio.
He added that the investment division would also target low-cost strategies, including flat-fee and reduced-fee mandates. In particular, the division will advocate for discounted terms of a 1% management fee and 10% performance fee—half of the traditional 2-and-20 model—as well as a flat management fee of 0.75% to 1.25% with no performance fee for risk-mitigating strategies.
Overall, he said the allocation reduction and low-fee initiatives would produce savings of $127 million annually once the portfolio restructuring is complete.
“It sends a message to the hedge fund community that the world has changed,” Byrne said. “Public funds aren’t going to just pay whatever they’re charging.”