AIG's Losses Show The Smart Money Has Largely Avoided Hedge Funds

William Heyman, the longtime chief investment officer of Travelers , knows a lot about hedge funds. In 1979, he started one of the first risk-arbitrage hedge funds. In the 1990s, he ran Sandy Weill’s internal hedge fund, Tribeca Investments, at what would become Citigroup .

But in running Travelers’ $72 billion investment portfolio in recent years, Heyman has been very choosy about investing in hedge funds. With a few exceptions, he has mostly avoided them as the asset class kept charging its customary high fees while producing disappointing returns. “It’s great that there are institutions who will pay 2% for an 8% return,” Heyman said last year. “We are not one of them.”

Most hedge funds would kill for an 8% return these days. Many hedge funds have been hit hard by the gyrations of financial markets in the last six months. But this has not had an outsized impact on Heyman’s portfolio at Travelers. In its recent financial report, the only property and casualty insurer in the Dow Jones Industrial Average reported that lower hedge fund returns were largely responsible for net investment income generated by its non-fixed maturity investments coming in at $44 million, a decrease of $25 million from the same period a year earlier.

Contrast the results at Travelers with the goings on at AIG, which over the years built up an about $11 billion hedge fund portfolio that consisted of investments in about 100 funds. At AIG, a $537 million pre-tax loss in market value of hedge fund holdings helped turn the insurer’s earnings negative in the first quarter as it lost $183 million. It was the third quarter in a row that AIG’s hedge fund portfolio significantly dented its bottom line. AIG wrote down $220 million in hedge fund-related assets in the fourth quarter and $324 million in hedge fund assets in the quarter before that. In total, that’s $1.08 billion of hedge fund mark-to-market losses in the last nine months.

AIG has now said that it is retreating from hedge funds. It has started the redemption process for $4.1 billion of its hedge fund investments. AIG has so far gotten $1.2 billion of that cash back and it will take a while for AIG to get the rest back under normal hedge fund operating procedures.

It’s not an accident that Carl Icahn is pressuring AIG and not Travelers or Chubb , another well-run major insurer with an annual report that shows hedge funds are not a meaningful part of its investment portfolio. Chubb says its exposure to hedge funds is "de minimis and represents less than 0.5%" of its investment portfolio.

At Travelers, Heyman navigated the insurer through the financial crisis with nary a problem because he largely avoided subprime loans and toxic derivatives. Unlike AIG, there was no bailout at Travelers.

Often, it’s the investments you don’t make that really matter.