Last month, we discussed investor disappointment with poor returns and the likelihood that they will run to another money-making specialist. In fact, we found that many investors are likely to mill around, complain and leave their money where it is. It appears that even those managing large portfolios may subscribe to the idea that misery loves company.
Unhappy with some of the fees paid to its army of stock and bond masters, CalPERS, the giant $300 billion fund that serves California public employees and ranks as one of the world’s largest pension investment organizations, appeared on the verge of taking its money and running. The year 2014 produced a solid +18.4% return according to their website. Private equity managers handle 10% of the total. Within that segment, hedge funds administer about $4 billion. They had a weak year, generating only +7% while taking about half the earnings for their expert advice. This sounds like a good reason to take the money and run. Imagine a CalPERS executive at a meeting: “At this rate, we might as well keep the funds in a money market or a mattress!”
Would that make sense? A money market may generate a yield of roughly .55%, but if it carries an expense ratio of .46%, the net approaches zero. Who would invest money and earn nothing? Don’t laugh. This is about where US government bonds leave investors and zero return outperforms risky investments that do not perform such as crude oil or the ruble.
According to New York Times Deal Book (January 20, 2015), giant CalPERS is not planning to reduce the amount of the fund invested with private equity managers, only the number of private equity managers. So, they are opting for quality over quantity. In recent lean years for massive portfolios, more funds went to private equity managers in hopes of beating a disappointing market outlook. So, CalPERS also appears to be milling around, having second thought and not taking their money and running.
Shameless Investment Managers
Surely miserable returns combined with high fees make investors run with their stockpile. The NYSA Fund (NYSAX) ranks at the bottom with a return of -42.4% year to date according to Yahoo Finance. Morningstar gave them a dismal one starand USA Today ranked them worst. The fund holds a good number of junk bonds, which once looked attractive, but their other holdings flopped last year. Yes, many investors ran with their money. After all the withdrawals, the fund is pretty small. Given such poor results, were the NYSA managers ashamed? Perhaps in a bad year, they would scale back their fees and take only crumbs in remorse? NYSA’s expense ratio is an astounding 5.41%. No wonder they are the mere shell of their former self.
The CalPERS and NYSA scenarios highlight the issues that really motivate investors. Especially as a new year opens, the savvy shift toward attractive alternatives. In previous years, high yield bonds looked good. The mighty BRICS had a good run and may still turn their fortunes around. Oil or gold might be the place to be, if other options plummet. Clear trends are in place for 2015. Passive, low cost mutual funds are experiencing an awakening. Vanguard’s passive funds have already accumulated more than $31 billion of new funds. With the down spiral of quantitative easing, bonds are looking up. These trends imply that the corpulent returns of last year will be rare.
Market watchers will also take heed that the massive exit from mighty PIMCO did not result in Janus, Bill Gross’s new domicile, gaining a massive windfall. Morningstar hammered at least nine PIMCO funds. These downgrades made it appear that other fund families are more likely to come through in 2015. So much for the personality cult idea.
Risk is always a factor for investors, but consider what actual portfolio managers have done. In the case of CalPERS, they railed and fumed but did not shift funds to other investments. They know that a portion of the pool should be held in higher risk alternatives, which will eventually have a good year. In addition, the market is saturated with low-yield bond and money market funds. Returns are low but security is high.
All in all, the myth has not held up well, despite deep-seated feelings that this should be standard behavior for weak returns. Investors certainly shift funds from one alternative to another, especially early in the year as the investment outlook firms up. Gold, BRICS, junk bonds, Euro stocks and large caps have seen massive inflows and outflows from year to year. But, investors are just as likely to complain loudly and stick it out, shifting funds slowly and deliberately, or in the case of the Common Fund (discussed in Part1), not shifting at all. Risk remains a worry, but, if consigned to a small portion of the portfolio, it is manageable.
Next month. The Myth Buster will tackle another intriguing truism from the world of business.
Michael McTague, Ph.D. is Executive Vice President at Able Global Partners in New York, a private equity firm.
DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer