Insurers have had about enough of hedge funds.
Stung by market-trailing returns, the industry in the U.S. is reversing course after more than doubling its hedge fund allocation over five years, to $17.7 billion as of Dec. 31, according to data from the National Association of Insurance Commissioners. Just this month, American International Group Inc. said it submitted redemption notices for $4.1 billion, and MetLife Inc. announced a plan to exit most of its $1.8 billion hedge fund holdings.
The shifts add to challenges for money managers who failed for years to match the returns of the S&P 500 and are facing investor withdrawals and criticism for high fees. Insurers pressured by low interest rates in their bond portfolios had been a steady source of capital for hedge funds, but negative returns in recent months, along with tight capital rules, have pushed the companies to rethink their plan. “The hedge fund universe is being painted with a very broad brush, directionally they haven’t performed,” said Matt Malloy, who oversees $22 billion for insurers at Neuberger Berman. Insurance companies “are reducing, like a lot of other institutional investors, but not exiting entirely.”
Malloy said some firms are shifting to “illiquid, yield-oriented strategies” that include real estate and private equity. AIG Chief Investment Officer Doug Dachille is betting on investment-grade bonds and commercial mortgages, which are treated more favorably by regulators.
Dachille, who oversees a $343 billion portfolio dominated by bonds, has been cutting funds that use strategies overlapping his own team’s approach. AIG is sticking with some funds that focus on equities, because it’s more cost-effective than hiring a large team to evaluate individual stocks, Dachille said. He also favors managers who invest a material component of their wealth alongside clients.
“It gets very worrisome when you see some of these big managers who start opening all these other series of funds,” Dachille said an interview this month, without naming firms. “And you start wondering, ‘Well, is their money in all these new funds that are popping up? Or are they just in the original fund that they started, and they want all these other funds to start generating fees?’”
JPMorgan Chase & Co., Goldman Sachs Group Inc. and BlackRock Inc. are among Wall Street firms that have advised clients to keep space in their portfolios for hedge funds. Mike Siegel, who is head of insurance asset management for Goldman Sachs and oversees about $190 billion, said the funds can help diversify portfolios that mostly consist of low yielding bonds. He said this month in an televised interview that the industry is experiencing a “day in the shade,” and that the model isn’t broken.
Mutual companies, which are often able to accept volatility in quarterly results because of their ownership structure, might find hedge funds attractive, said Mark Snyder, the head of institutional strategy & analytics at JPMorgan, which oversees about $85 billion for insurers. Beyond that, hedge funds could be a good fit for insurers that are willing to deal with fluctuations in quarterly results to guard against risks tied to bond yields or stock markets, said Snyder and Josh Levine, a managing director at BlackRock, which oversees more than $400 billion for insurers.
“We’re looking at lower returns and higher volatility ahead,” Levine said. “If you’re putting money into the market today, would you do it hedged? Or would you do it pure beta?”
Bill Limburg of Patpatia, a financial consulting firm, said companies like BlackRock and Goldman Sachs may provide a more attractive channel than directly investing in hedge funds. That’s because the big money managers have knowledge of insurers’ unique needs, which include dealing with ratings firms and state regulators.
Still, AIG has voiced reservations.
“You have a simple question: ‘Are they putting their shareholders’ money in hedge funds?”‘ Dachille asked of Wall Street. “If they think this is such a great investment, let’s see them do it for themselves, and then maybe I’ll be convinced.”
His company also cited regulation as one reason to limit hedge fund investments. Typically, the capital charge for such fund assets is about 50 percent “or even slightly north of that,” Chief Financial Officer Sid Sankaran said in a May 3 conference call, discussing how the investment shift could free up funds to return to shareholders.
MetLife Chief Investment Officer Steve Goulart said this month that he will stick with the “most consistently performing managers in hedge funds.” The insurer had investments with firms including D.E. Shaw & Co. and Davidson Kempner Capital Management at the end of last year, according to regulatory filings..
Two of MetLife’s subsidiaries pulled about $60 million from Aristeia Partners LP last year, according to regulatory filings. The insurer also redeemed more than $45 million from BlueTrend Fund, part of Leda Braga’s Systematica Investments, since the beginning of 2014, according to the filings. John Calagna, a spokesman for MetLife, declined to comment on those investments, as did Systematica and Aristeia Capital.
Loews Corp. CEO James Tisch, whose firm owns the insurer CNA Financial Corp., said three years ago that he counted on hedge funds to add “ zip” to the portfolio. This month, he said on a conference call that returns have been “ competed away” and that CNA has been reducing its allocation.
“They’re not getting out altogether,” Malloy said insurers. “They’re just taking a more discerning view of where they’re allocating their dollars, and they’re going to stick with firms or strategies and managers that have performed to expectations or exceeded expectations.”