“Hedge Funds Under Threat from Pension Fund Rethink.”

“Hedge Funds Lose CalPERS, and More.”

“CalPERS Gives Up on the Hedge Fund Dream.”

So reacted Bloomberg, Reuters, and other major news outlets to the decision by the $300 billion California Public Employees’ Retirement System (CalPERS) to unwind a $4.5 billion allocation to hedge funds in September last year.

It was a pivotal moment for asset owners everywhere, and one that nobody could ignore. The biggest pension fund in the US and one of the world’s most influential asset owners had drawn a line in the sand. It had crossed the Rubicon. Use whatever analogy you want: It was big.

Days after CalPERS’ announcement, Dutch metalworkers’ pension fund PMT said it was dumping €1 billion ($1.1 billion) of hedge fund investments. Another Dutch fund, healthcare workers’ pension PFZW—the second-biggest in Europe—netted an impressive $56 million profit as it unwound its allocation in November and December. The London Pension Fund Authority and the Railways Pension Scheme (Railpen) in the UK, and New Zealand Superannuation Fund also exited significant hedge fund mandates in the span of 18 months. The San Francisco Employees’ Retirement System was also reported to be cutting back on its allocation.

The collective result was that more than $10 billion had been snatched away from hedge fund managers by a handful of investors in the space of a few months, and many others would surely follow.

At least, so the headline writers would have you believe.

Art by Ellen Weinstein

“Get your facts first, then you can distort them as much as you please,” the scribe Mark Twain once noted.

He was speaking from experience: In a note to the New York Journal in June 1897, Twain found himself reassuring the writer that “the report of my death was an exaggeration.” A number of newspapers had mistakenly identified him as his cousin—who wasn’t dead either.

Similarly, at the start of 2015, the facts seemed at first glance unequivocal: Hedge funds were dead.

CalPERS CIO Ted Eliopoulos’ bold move, made at the very start of his tenure as permanent successor to Joe Dear in September 2014, prompted the activity detailed above.

Were these various funds’ decisions connected? It depends who you ask.

“When you look at what was driving the idea of pulling out of hedge funds, the scenarios are very specific,” says Peter Laurelli, head of research at eVestment. Regarding CalPERS, he points to the pension’s high concentration of assets in a small number of names. A $4.5 billion allocation was split between 30 funds, with some managers accounting for more than $500 million each—clearly a problem when trying to scale up the allocation to something more impactful to the broader portfolio. “To grow that out would have been a big undertaking, especially with a new CIO whose goal was to reduce costs,” Laurelli adds.

But for Ciaran Barr, investment director at the UK’s £20 billion ($30 billion) Railpen, the timing of the flurry of exits was “not completely” coincidental.

“A few things have coalesced,” he says. Essentially, he explains, these can be boiled down to costs, performance, and competition.

“We are expecting lower returns going forward,” Barr says. “In that world, a 2-and-20 fee model doesn’t make sense.”

It certainly didn’t make sense to CalPERS. In the 12 months to the end of June 2014, the pension’s financial reports show it paid $130 million in annual and performance fees to the managers in its Absolute Return Strategies program—an increase of 53.4% in two years. Overall, 11% of the fees it paid to all its managers in 2013 and 2014 went to a small group managing less than 2% of total assets.

High costs were also cited by PFZW’s Jan Willem van Oostveen, managing director for financial and investment policy, who said at the beginning of January that “with hedge funds, you’re certain of the high costs, but uncertain about the return.”

If you are one of those paying a 2% annual charge and giving up 20% of any profits, you may have yourself to blame, however.

“Many years back in the history of hedge funds, there were discussions about 2-and-20,” says Stefan Ros, CIO of Swedish bankers’ pension fund SPK. “We have never seen that—we have always negotiated lower. In the last three or four years we haven’t seen 2-and-20 anywhere. At SPK, we have a reputation of turning all the details upside down and digging into them, and one of those details is fees.”

Ros, along with CEO Peter Hansson, last year completed an overhaul of their SEK 18.4 billion ($2.2 billion) portfolio, which included a 12% allocation split between hedge fund manager Brummer & Partners and risk premia specialist Ramius. Bespoke mandates meant Ros and Hansson could negotiate lower fees.

“When you look at what was driving the idea of pulling out of hedge funds, the scenarios are very specific.”

According to data provider Preqin’s 2015 global hedge fund report, the fee model that many feel is the industry standard is actually only used by a third of single-manager funds. Two-thirds charge an annual fee below 2%, and the average charge has fallen steadily since 2008.

Preqin argues that inconsistent returns from the various hedge fund strategies combined with scrutiny of charges “could add further weight to the bargaining power in favor of investors” this year. This could lead to “a new, lower ‘standard’ fee structure across the industry.”

SPK’s Hansson believes that, in the past, hedge fund fees may not have been negotiated down by many investors, but “that is turning in another direction” now.

In the furthest southwest corner of the UK, the £1.5 billion ($2.3 billion) Cornwall Pension Fund is turning in another direction as well—the opposite to that taken by CalPERS. In January, the pension announced the appointment of FRM, a subsidiary of listed hedge fund manager Man Group, to run 8% of its portfolio in a bespoke fund-of-hedge-funds mandate.

One of the key features of the mandate is a “sliding scale” fee structure, meaning that the headline charge will fall as assets on the platform rise. Both Cornwall and Man Group hope more public pensions will follow this lead to benefit from the economies of scale a larger asset base will bring.

In the period before the financial crisis—between 2003 and 2007—Eurekahedge performance data shows hedge funds made 13.4% a year on average. In the period 2010 to 2014, annual returns fell to an average 6.6%, while the S&P 500 gained an average 15.9% a year in the same post-crisis period.

A period of low returns should not be a huge concern for investors on its own, but as Railpen’s Barr says, diversification is not what it used to be.

“Diversity was shown to work well in good times but not in bad,” Barr states. “Hedge funds were no more immune in the crisis than anything else, and you were picking up more market beta than you might think. Also, they bounced back with everything else.”

The Eurekahedge data shows that, with the exception of managed futures funds, most segments of the hedge fund universe did not protect investors from the fallout from the collapse of Lehman Brothers in September 2008. When they bounced back, most did so in line with major equity markets.

Performance is diverging across strategies as well. Pre-2008, all hedge fund subsectors covered by the data provider were on a broadly similar upward trajectory: Between 2005 and 2007, the difference between the best and worst performing sectors barely reached 10 percentage points, but since 2010 it has rarely been below this level.

A report published in October by PricewaterhouseCoopers and UBS highlights what the companies claim is a change in investors’ expectations. Rather than seeking the double-digit returns more often achieved before the 2008/09 crash, investors want lower fees, more transparency, and lower correlation.

Cornwall’s Pension Investment Manager Matthew Trebilcock is under no illusions regarding returns: the pension’s allocation is not seeking to “shoot the lights out,” he says, but is instead aimed at reducing overall portfolio volatility and diversifying away from other recently added mandates. “Other funds may have been looking at the hedge fund asset class to provide a very different driver in their portfolios from that which we are seeking,” he says. “The hedge fund universe is vast and contains myriad different strategies, styles, and return expectations. There are examples of good and bad practice and returns in all asset classes, but as a fund you must be focused on why you are investing into an asset class and the outcomes that you expect from it.”

Performance has also been hampered by declining liquidity conditions. As banks have withdrawn from their traditional roles as market makers, shifting a large chunk of cash quickly is increasingly difficult.

However, this is not a reason to divest, according to Europe’s largest pension fund, APG. The Dutch pension has a 5% strategic allocation to hedge funds. Within a €288 billion ($326 billion) portfolio, this allocation is more than four times the size of CalPERS’, but any liquidity issues are not going to put off APG’s hedge fund investor New Holland Capital.

“It’s becoming harder to trade $500 million than it was a few years ago,” CIO Eduard van Gelderen told CIO in September. New Holland “comes up with signals that the number of opportunities in the market is falling. But it certainly doesn’t lead us to the conclusion of getting rid of our hedge fund exposure.”

Cornwall’s example of a bespoke hedge fund mandate is almost certainly set to become more popular in the years ahead. In September, Preqin reported that 29% of investors it surveyed were using managed accounts, or segregated mandates, to access the asset class. This method allows greater transparency of holdings, better liquidity, and the ability to customize the mandate—boxes ticked for Cornwall.

As Trebilcock explains—having implemented a liability-driven investment mandate with AXA Investment Managers and added diversified growth and frontier markets allocations—FRM was tasked with tailoring the hedge fund exposure to ensure proper diversification of risk.

SPK took a similar approach last year. CIO Ros refers to the two mandates as a “bespoke optimizer of the total portfolio within our risk limits,” with Ramius and Brummer plugging the gaps in the portfolio’s risk exposure.

“It’s not that we wanted the asset class by itself, it’s that it was a good complement to the rest of the portfolio,” he explains.

Cornwall and SPK’s actions reflect a change in ideology that has taken place in the past five years, Railpen’s Barr argues. “The other thing that changed psychologically after the crisis is that institutional investors realized they really needed to own their own decisions,” he says. “As an investor, you need to understand how these strategies work; you need to trust the managers. Institutions are now saying that ‘we’re on the hook and we want to have more control.’ People are being choosier.”

The tools at investors’ disposal are growing more numerous, he adds. The rising profile of UCITS-compliant funds in Europe and beyond is bringing hedge fund strategies such as long/short equity to the regulated markets.

For Barr, the message is clear: Hedge funds are not dead—Railpen still has some small holdings—but “they need to work for us, be consistent with our strategy, and we need to get a good share of the returns.”

Hedge fund appetite is not only strong in Europe. The CalPERS narrative and the intense level of scrutiny under which US public pensions have been placed have ensured those sticking with hedge funds are keeping quiet.

Nevertheless, Preqin’s research shows 22% of all institutional capital invested in hedge funds comes from public pensions; more than a third of hedge fund managers reported an increase in cash from public pensions in the first half of 2014; and 26% of all investors intend to put more money into the asset class.

The Chicago Policemen’s Annuity and Benefit Fund advertised for a $360 million, multi-strategy fund-of-hedge-funds mandate in October, which would make up 11% of its $3.1 billion portfolio. The Austin Police Retirement System in Texas and Pennsylvania Turnpike Commission Retiree Medical Trust also announced new hedge fund mandates in the second half of 2014.

“There are more US public pension funds than ever before allocating capital to hedge funds,” says Amy Bensted, head of hedge fund products at Preqin, “and these investors are investing the most they ever have in the asset class.” An estimated $355 billion was added to the hedge fund industry’s asset base in 2014, pushing the total past $3 trillion for the first time. CalPERS et al. are starting to look like a non-event. Hedge fund investors are not going to be put off that easily.

Then again, neither are headline writers. As Mark Twain succinctly put it, “I like the truth sometimes, but I don’t care enough to hanker after it.”