A new vision of hedge funds is emerging in which they could have a much bigger role to play in portfolio management. Under the new scenario, the conventional image of a hedge fund as two guys with a terminal, swinging for the fences, is passé. While a lot of attention has been paid to what hedge funds have done wrong, too little attention has been paid to what they have done right, which is to strive to help investors avoid losses. That's because without much fanfare, the largest hedge funds have evolved into the world's most sophisticated risk management vehicles.
According to this perspective, the traditional 60% stocks/35% bonds/5% cash portfolio is beginning to resemble a car that has only one gear—forward. In hedge funds, by contrast, investors see the equivalent of a car that can go forward, backward, sideways, up and down.
Instead of allocating 10% of their portfolios to hedge funds, some pension funds are using them across all of their portfolios' asset classes. The Employees Retirement System in Texas, for example, recently decided to integrate hedge funds across its entire $24.9 billion portfolio. The move was particularly notable because the Texas Retirement System only began investing in hedge funds in 2011, according to Institutional Investor magazine. Similar actions were taken in the Teacher Retirement System of Texas and the Virginia Retirement System.
In Geneva, the head of the pension fund for CERN, the world's largest particle physics laboratory, is running its 4-billion Swiss Franc ($4.37 billion) portfolio as if it's one big global macro fund. Theodore Economou, CEO of the CERN Pension Fund and the person behind the so-called CERN Model, thinks all pension funds should adopt CERN's approach. If they can't, Economou has proposed a radical solution: turn the entire pension portfolio over to a large hedge fund that can.
Integrating hedge funds across an entire portfolio may sound as if chief investment officers want to put their portfolios on steroids. In fact, their motive is just the opposite. They're making the judgment that hedge fund managers are no longer a one-off entity to which you might allocate a small slice of the portfolio. Rather, they are relying on hedge funds to deliver a sophisticated set of tools to each of their asset classes.
