The hedge fund model has been under attack for at least decades since the financial crisis, but assets under management continue to surpass records. Christopher Ailman oversees the country’s second largest public retirement fund, CalSTRS, with $ 300 billion in assets under management. Here he talks to Leslie Picker about the high cost of providing alpha.

The following content has been edited for length and clarity.

Leslie Picker: Chris, I want to ask you very clearly: do you think active managers deliver alpha?

Christopher Ailmann: I’ve been hiring active managers since the mid-1980s, with a wide variety of funds. Well, those were all government plans, so maybe that’s a caveat that I have to add. Our active managers in US stocks added value and produced alpha, but not after fees. And that is the critical point. I think Alpha is expensive, hard to find, but the price is too high. And so the net even over a period of one year, three years, five years, or even a 10 year period, we have seldom seen managers achieve constant value minus fees.

Picker: So if hedge funds were to cut their fees, how much would they have to go to trick you into investing more money in this area?

Ailmann: Well, I said a long time ago that I think the 2 and 20 model in private equity real estate and hedge funds is broken. And for a fund of this size like us, we don’t pay the classic 2 and 20. So that’s part of the key. And I’m a fan of profit sharing, I think an incentive for the manager and profit sharing makes sense. The problem is, it only goes one way. They divide on the top, they don’t get hit on the bottom. And we haven’t found a way to make a good plan for it yet.

Picker: Why hasn’t the industry rejected the 2-and-20 model so strongly? Why do you seem to have a somewhat contrary view in this regard? I’m sure people don’t like to pay 2 and 20, but they keep doing it.

Ailmann: I have to say # 1, good marketing, but it’s also the cool place to invest. People love the idea of ​​being in a hedge fund because it sounds mysterious and great. Hedge funds did really well in the late 1990s because they diversified outside of TMT, they did well in 2007, but the best performers were the funds with the least added value. If you are a huge investor like us we are going to flood your AUM and make you really invest in more strategies than you want to. So I think the wealth for this area will continue to grow. First, because it’s an interesting place to invest, it sells, it has a good selling point. That doesn’t mean it will produce sustainable results in the long run.

Picker: I want to pan a little and talk to you about what the hedge fund industry has seen this year. I mean, they were the disruptors of Wall Street three decades ago. And now they’re really playing a defense against a number of new retailer disruptors that don’t charge a 2 and 20. You can take as much risk as you want because you only worry about your own capital, you don’t have to worry about losing the capital of CalSTRS or the capital of family offices. Do you think this will change the hedge fund industry? Do we want to look back and say that this is where the upheaval took place?

Ailmann: The answer is yes, Leslie. I think for a really short time the hedge fund industry was seen as cool and these people were great. They just started up and are despised. I’m not surprised to see that all the young people in the hedge fund industry want some meat. People under 20 don’t like the establishment. I was in the baby boom, we didn’t like the establishment, now we are the establishment. So I don’t think it will get rid of the hedge funds. But I think this is actually a really interesting change that we are seeing. They said their transaction costs are zero. You can trade stocks for free. You can do this on your phone wherever you are. So the efficiency and effectiveness of their work is so quick. Now they are speculating and they are just acting fast so don’t invest. But I think some of the different apps that are designed to force this generation to save are huge. In previous generations, people didn’t start investing until they were 40 or 50. You have a whole generation that is now saving for the first time. And yes, they speculate, they invest in cryptocurrencies. Speculation in and of itself is not good and you will learn some hard lessons, but you are starting to save up and that is enormous. If they can now figure out how to do it in the long run and get compound interest, they will really be a little better off as a generation.

Picker: There have been some people who have said that the speculative activity out there has been disruptive and has affected confidence in the overall market. Do you think this type of behavior needs to be regulated?

Ailmann: I would say no, not at all. The market will correct itself. We saw that in media, telecommunications, and technology stocks in the 1990s. You can get the Dutch tulip craze in [1600s]. You see periods of rampant speculation, exorbitant prices, ridiculous prices, the markets correct and it comes back, people learn a hard lesson. Perhaps those communications networks need regulation and that kind of herd mentality that was clearly a crowd seems to go on after you’ve been trading at five times the float of a stock on a daily basis. Short squeeze was already on the market in the 1930s and 20s. So it’s a natural part of the market. That’s unusual, it’s disruptive to, I’m just saying, mature people like me who like a stable market, but it’s not bad. It’s about engaging and actively engaging the young audience and learning how to tolerate risk.

Correction: The Dutch tulip craze occurred in the 17th century. In an earlier version, the period was incorrectly specified.