Calpers CIO Says His Hedges Worked Better Than Taleb’s
Calpers CIO Says His Hedges Worked Better Than Tail-Risk Funds
(Bloomberg) -- The California Public Employees’ Retirement System defended its decision to eliminate a tail-risk hedging program and said the alternatives it put in place offset $11 billion of losses during the March sell-off.
Calpers, as the giant pension plan is known, has faced scrutiny since Bloomberg reported on April 9 that it missed out on a payout of more than $1 billion by terminating one of two tail-risk hedges just weeks before stock prices crashed. That hedge was managed by Universa Investments, a Miami-based firm advised by Nassim Taleb, author the 2007 bestseller “The Black Swan.”
“We chose better alternatives for market drawdown protection and they turned out to be better alternatives in the recent market rout,” Calpers Chief Investment Officer Ben Meng said on an April 15 webcast.
A second hedge was in place long enough for Calpers to make several hundred million dollars. The pension fund has more than $370 billion in assets.
Meng addressed the decision to exit the hedges for almost 14 minutes on the webcast, noting that he had received questions about it. Had Calpers known that the coronavirus pandemic was coming, he would have shorted the market rather than simply keeping tail-risk hedges on.
“That would have been a less expensive and more scalable strategy,” he said. The webcast video was available on YouTube before access was restricted Friday.
Of course, no one predicted the scope and speed of the viral outbreak, so Calpers like most investors was caught off-guard. At one point, the value of the Sacramento-based pension plan was down $67 billion.
Taleb responded to Meng’s defense in a video posted in the Naked Capitalism blog, calling it “extremely unrigorous.” He also asserted that the same strategy Meng says offset $11 billion of losses in the recent collapse would have cost Calpers $30 billion in underperformance in previous years.
“Not a great trade,” he said. “He just doesn’t know probability.”
Meng briefly detailed the “matrix” of tools he chose to employ instead of tail-risk hedging. They include factor-weighted equity exposure and long-duration Treasury holdings.
In 2017, Calpers hired two firms to provide tail-risk protection for billions of dollars of its public-equity exposure: Universa and LongTail Alpha of Newport Beach, California.
Meng described that decision, made before he became CIO in January 2019, as an “experiment.” Upon review, Calpers determined that the program was too expensive and difficult to implement effectively at a fund of its size.
Having such hedges in place cost 3% to 5% annually, or $30 million to $50 million on every $1 billion protected, according to Meng. If a portfolio of stocks is expected to earn a gross return of 6% to 7%, an insurance policy that expensive makes no sense, he said.
Universa Chief Operating Officer Brandon Yarckin disputed those calculations. In a statement Friday, he said the annualized cost of Universa’s tail-risk hedge was only 1% to 1.5% of assets under protection from August 2017 through January 2020, the period when when Calpers was a client and the S&P 500 returned about 37%.
“We objectively dramatically slashed the risk of that S&P exposure,” Yarckin said. “Our portfolio-level costs were much, much less than other traditional factor-weighted or long Treasury positions.”
Meng also questioned the capacity available in the options market to support tail-risk hedging for more than $10 billion of exposure.
Calpers decided in 2019 to terminate the program and removed the Universa hedge this January.
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