This is the ‘last straw' that led Rhode Island's treasurer to dump hedge funds

Rhode Island became the latest state to cut its exposure to hedge funds in its state pensions, slashing it by $500 million.

State Treasurer Seth Magaziner appeared on CNBC's "Power Lunch" on Thursday and said the new "back to basics" plan would reallocate hedge fund money into more traditional asset classes over the next two years. The last straw, he said, has been the under-performance by some hedge fund managers during periods of market volatility.

"They did not perform well and they did not provide protection during the periods of volatility that we've had over the last year, and that protection is a big part of the rationale for why many of these managers exist," he said.

Magaziner said since he took office in January of 2015, the state has made $400 million in investment gains on the $8 billion fund. He said they have also had positive performance for the last six months and have beaten internal benchmarks, despite hedge funds being "a lag."

The state investment commission approved a new asset allocation on Wednesday, he said. Magaziner explained the state would be "bumping up" its treasuries to help in the next market downturn. He also expects to gradually increase the state's investment in private equity, adding he wants to remain diversified in a way that "de-emphasizes the role of the hedge funds."

Once the plan is completed, 40 percent of the $8 billion pension will be allocated to low-fee index funds. The state's investments are up 5.6 percent this year.

— CNBC's Kate Kelly contributed to this report.