60 Finance and economics The EconomistJanuary 20th 2018
12 expense of oil consumers in the West.
Over time, however, the rich world has
become less reliant on oil. Demand in
America peaked in 2005, for instance.
Meanwhile, oil exporters became ever
more dependent on high oil prices to pay
for lavish government budgets and import-
ed consumer goods. Most ofthe big oil pro-
ducers in the Middle Eastneed an oil price
above $40 to covertheir import bill (see
right-hand chart on previouspage).
In this new arrangement, dearer oil is
both far less damaging to rich-world con-
sumers and soothes the strained finances
of the bigoil exporters, not justin the Mid-dle East but in Africa, too. For all the other
trouble-spots, investors seem to find the
world economy a safer place. And they
have other reasons to feel cheery. The shale
industrymeans that dearer oil is a shot in
the arm for investment in America, which
adds to GDPgrowth. And a rising oil price
is taken as a sign of healthy growth in Chi-
na, the world’s biggestoil importer.
Beneath the dramatic ups and downs in
the oil price and its changing influence on
the world economy are some big themes:
the rise of the shale-oil industryand how
OPEC responds; the dependence ofthe big
oil exporters in the Middle East on high oilprices; the peak in oil demand in America
and eventually elsewhere. These forces
will have a big say in where oil prices even-
tually settle.
How they will play outis the subject of
a new paper by Spencer Dale, chief econo-
mist ofBP, another oil giant. The critical
change in the oil market, he argues, is from
perceived scarcity to abundance. When oil
was considered scarce and expensive to
find, it seemed wise to ration it. It was more
like an asset than a consumer good: oil in
the ground was like money in the bank.
But new sources of supply, such as shale
oil, and improved recovery rates of exist-H
EDGE-FUND managers may be feel-
ing quietly smugabout their perfor-
mance in 2017. They returned 6.5% on av-
erage, according to Hedge Fund Research,
a data provider, their best year since 2013.
But those returns do not reallysuggest
that they are mastersof the investing uni-
verse. The S&P500 index, America’s main
equity benchmark, returned 21.8%, in-
cluding dividends, last year. More telling-
ly, a portfolio split 60-40 between the S&P
500 and a mixture of government and
corporate bonds (an oft-used benchmark
for institutional portfolios) would have
returned 14.8%. Last year was the fifth in a
row when hedge funds underperformed
the 60/40 split (see chart).
That ought to be a salutary lesson for
those institutions who think that backing
hedge funds is the answer to their prayers.
Despite the highs recorded by stockmark-
ets, many employers are struggling to
fund their final-salary pension promises.
In 2016 the average American public-sec-
tor plan wasjust 68%-funded, according
to the Centre for Retirement Research at
Boston College. In the private sector,
multi-employer pension plans, covering
workers in industries like mining and
transport, have liabilities of $67.3bn and
assets of just$2.2bn. Worse still, the insur-
ance scheme established to back those
schemes is on course to run out of money
by 2025, according to the Pension Benefit
Guaranty Corporation.
It is hard to cut workers’ benefits and
painful to increase contributions.
Schemes hope to square the circle by
earning a high return from their assets;
7.5% is a common target. But bond yields
are very low and equities are trading at
very high valuations by historical stan-
dards. The temptation is to turn to “alter-
native assets”—a category that includes
property, private equity and hedge funds.The first two offer a genuine alternative.
Property generates a stream of rental in-
come and the hope that capital values will
keep pace with inflation. Private equity is,
in part, a bet that unquoted firms can gen-
erate higher returns than listed ones be-
cause they have more freedom to invest for
the long term.
But what about hedge funds? A lot of
funds specialise in equities or corporate
bonds—the same assets that institutions
own already. In some other categories,
such as macro funds or merger arbitrage,
returns are entirely dependent on the man-
ager’s skill. Recent years do notsuggest that
hedge-fund managers display enough
skill, on average, to offsettheir high fees.
Clients may think they will be able to
pick the best hedge-fund managers, not the
average ones. But one group of profession-
als—fund-of-fund managers—tries to do
just that. They did manage to pip the aver-
age asset-weighted return of hedge funds
in 2017, but failed to do so in any of the pre-
vious four years. If the experts cannot
manage to pick the winners, why should a
pension fund or endowment be able to
manage the feat?Anotherjustification for placing mon-
ey with hedge funds is that they are less
likely to lose lots of money in a downturn.
That argument was somewhat dented in
2008, when the average hedge fund lost
19%. In any case, pension funds and en-
dowments are investing for the long term;
they ought not to be that bothered by
short-term volatility.
The Centre for Retirement Research
conducted a study* of the effect of invest-
ing in alternative-asset categories on state
and local-government pension-plan re-
turns in the 2005-15 period. It found that
schemes that placed an extra 10% of their
portfolio in private equity and property
had marginally increased the return on
their portfolios (by around a sixth of a per-
centage point). But investing in commod-
ities or hedge funds had reduced returns,
with the latter knocking half a percentage
point off the total.
Some investors have seen the light.
CalPERS, a public-pension fund in Cali-
fornia, announced that it was pulling out
of hedge funds in 2014. But Preqin, an in-
formation provider, estimated lastyear
that pension funds accounted for 42% of
all money flowing into the global hedge-
fund industry. North America provided
the bulk of the money, with 776 pension
schemes investing from that region alone.
Who knows what those schemes are
trying to achieve? A few of them may be
lucky enough to pick the best performers
in the industry. But ifthey think, in aggre-
gate, that their strategy will reduce their
funding deficits, then they are suffering
from a delusion.The hedge-fund delusion
Pruned hedgesSource: Hedge
Fund Research*S&P 500 plus Barclays
Government/Corporate-bond indexAnnual returns, %505101520+- 2013 14 15 16 17
Hedge funds, asset-weighted
60/40 equity/bond split*Buttonwood
Hedge funds do not offer the answer to pension-scheme deficits..............................................................
*“A First Look at Alternative Investments and Public
Pensions” by Jean-Pierre Aubry, Anqi Chen and Alicia
Munnell, July 201 7Economist.com/blogs/buttonwood