One of the big stories inside the investment community over the past 18 months is the announcement by the California Public Employees Retirement System (CalPERS) that they are eliminating their hedge fund exposure and significantly cutting back their private equity exposure (which we wrote about here and here).

These are two of the three asset classes that large institutions use that we don’t (the third being direct investment in commercial real estate).  We wanted to avoid high cost, low liquid investments that are often not very tax-efficient.

It was interesting to see the largest investor in the world, CalPERS, cut back on the asset classes that we couldn’t do because they wanted to reduce costs and complexity, especially given the lackluster returns they were apparently achieving.

Last week, according to the Wall Street Journal, the nation’s second largest pension fund, the California State Teachers’ Retirement System (Calstrs) has decided to go in the opposite direction and discussed cutting exposure to classic stocks and bonds and adding to hedge fund strategies.

The risk mitigation approach contains four strategies: global macro, managed futures, systematic risk premiums and exposure to long-term US Treasury bonds.

Global macro refers to betting on big macro-economic events, like whether Japan will increase their quantitative easing program, which would mean selling Japanese yen and buying Japanese stocks and bonds, for example.

Managed futures are a form of trend following that attempt to own stocks, bonds, currencies and commodities while they are rising in value and sell these same assets short when they are falling in value.

It’s hard to know what they mean exactly by systematic risk premiums, but it probably refers to market neutral exposures to common risk premiums like credit or value, for example.

Simply buying long-term Treasury bonds isn’t exactly a hedge fund strategy and doesn’t sound risk-mitigating on its face, but the idea is that when other markets are falling, especially sharply, nothing responds better most of the time than long-term Treasury bonds.

In an industry publication, one of Calstrs consultants says they think these moves should increase returns by 0.1 percent per year, cut volatility by about 10 percent (from 14.4 percent to 13.2 percent) and increase fees from 0.33 to 0.46 percent.

You can look at those numbers and say that returns are likely to be about the same, but that the overall volatility will be lower, which is why they refer to these as risk-mitigating strategies.

They’re also expensive because a 12 percent allocation costs them an additional 0.13 percent in fees and it’s not as if what they are coming out of doesn’t cost anything.

It’s interesting to think that two of the largest managers in the world, both headquartered in California, would be taking such divergent approaches.  These are relatively small allocations for both of them, but still, you would think that they would be talking to each other.

Since we don’t really pursue these strategies, it’s more of a spectator sport and it’s interesting when two of the big boys take opposite sides of the same trade.  Now, we just have to wait five years and see what happens.