A Hedge Fund Sales
Pitch Casts a Spell on Public Pensions
It has been just over a year since the
California Public Employees’ Retirement
System said it would
wind down its $4 billion
portfolio of hedge fund holdings. High costs and complexity made the
vehicles “no longer warranted,”
Calpers said at the time.
Calpers’s leadership in the public pension arena, some thought other
pension managers and institutional investors would follow suit. But
that does not appear to be happening, even during this, a trying year
for hedge fund performance. The question is, why not?
Tobe, a pension consultant and former trustee for the Kentucky Retirement
Systems, said most public pension funds seemed to be sticking with hedge funds,
known as alternative investments, in spite of mediocre returns. “I’m seeing huge
increases in alternatives among public pension funds,” he said in an interview.
“Nobody seems to care about performance.”
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For the first nine months of this year, that performance has
underwhelmed; hedge funds, which hold $324 billion in public pension
money, eked out a net 0.18 percent gain, according to
Preqin, a data analysis firm.
That’s certainly better than the 2.6 percent loss recorded during the
period by the Standard & Poor’s 500-stock index, but meager hedge fund
returns like these are nobody’s idea of great.
contending that hedge funds provide outsize returns, their supporters say the
funds have another big selling point: Their returns are not correlated to the
stock market. That means they move independently of the market when it goes up
shows that hedge funds are becoming more and more correlated to the overall
stock market. They are less likely, it turns out, to perform as a hedge against
a balanced portfolio’s other holdings.
pensions turn to hedge fund managers is to try to close the expansive gap
between what the pensions owe their beneficiaries and the amount of funds that
they have to meet those obligations. According to a
report by the Pew Charitable Trusts, that
gap was around $1 trillion in 2013, the most recent year available.
funds can actually help fill pensions’ coffers is the question responsible
trustees must try to answer. Few are financial wizards, so it’s hard for them to
truth-squad the sophisticated sales pitch.
Some data is
emerging, though, that raises serious doubts about the benefit of hedge funds
for big investors with a long-term perspective. Utah, for example, increased its
holdings in hedge funds and
private equity in recent years. By 2013,
those allocations at the Utah Retirement Systems had reached 40 percent of
assets under management, up from 16 percent in 2005.
Have its hedge
funds helped the Utah pension’s investment performance? A May 2015
report to the Utah Legislature suggests
not. Prepared by the Office of the Legislative Auditor General, the report
concluded that if the state’s retirement system had maintained its 2004
allocation with fewer alternative assets and no hedge funds, the pension fund
would have gained $1.35 billion in additional assets by 2013.
A new report, “All That Glitters Is Not
Gold,” draws a similar conclusion. Conducted by researchers for the
American Federation of Teachers, the report
examined the hedge fund performance of 11 large public pensions and found that
these investments exacted a high cost, had laggard returns and generally moved
in tandem with the overall stock market.
“The report was
really intended to give information to pension trustees so they could ask the
tough questions and fulfill their fiduciary duties to the funds and their
participants,” said Randi Weingarten, president of the teachers’ union.
funds scrutinized in the report have $638 billion in assets under management,
$43 billion of which was in hedge funds as of the most recent fiscal year. The
11 funds had varied experiences with hedge fund allocations, so the report
studied only those years that a fund owned the vehicles.
That meant some
of the analyzed returns stretched over longer periods than others. The
Teacher Retirement System of Texas has been
investing in hedge funds since 2002, for example, while the
Employees’ Retirement System of Rhode Island
has invested since 2012.
Over a total of
88 fiscal years studied, the report concluded that the pensions’ hedge fund
stakes generally trailed those of each overall fund. For every pension fund
reviewed, the total fund portfolio outperformed the hedge fund piece over the
period in which hedge funds were in the mix.
In slightly more
than one-quarter of the years analyzed, the hedge funds outperformed a same-size
total fund’s returns, but that failed to make up for lower returns in other
years. This lackluster performance translated to $8 billion in lost investment
revenue at these funds, the report said.
managers, meanwhile, collected an estimated $7.1 billion in fees from the
pensions, it said. That averages out to 57 cents of every dollar in net returns
earned by the funds.
authors, Elizabeth Parisian of the A.F.T. and Saqib Bhatti of the
Roosevelt Institute, could only estimate
hedge fund costs because many appear in confidential contracts. They took a
conservative approach, assigning a 1.8 percent management fee and an 18 percent
cut of gains.
Fee secrecy is a
major problem with hedge funds and private equity investments, according to
Edward Siedle, a forensic pension investigator at
Benchmark Financial Services in Ocean
Ridge, Fla., and a former Securities and Exchange Commission enforcement lawyer.
“When I started
with the S.E.C. 30 years ago, there were two things that the regulators and the
regulated agreed on: Money management fees would come down over time and
transparency would increase,” Mr. Siedle said in an interview. “But just the
opposite has happened. Fees are at a historic high and transparency at a
teachers’ union report turned up compelling data on how closely hedge funds’
performance mimics that of the overall market. Ten of the 11 pension funds
reviewed in the report demonstrated “significant correlation” between the
performance of the hedge funds they invested in and the performance of the
overall fund. The similar returns occurred even during the 2008 crisis, the
portfolios among the nine pensions providing information about these accounts
showed less correlation, the report said, at a much lower cost.
Howard Crane, a
former trustee of the
Colorado Public Employees’ Retirement Association,
said in an interview that hedge funds, as currently constructed, pose real
problems for public pension funds.
“The manager is
being paid upfront 2 percent with certainty, and the client is given 80 percent
of the net return, after the fact, with uncertainty,” he said. “I think it’s
unconscionable in the context of taxpayers who get to foot the bill if something
A version of this article appears in print on November 8, 2015, on
page BU1 of the New York edition with the headline: A Sales Pitch
Casts a Spell on Pensions.
© 2015 The
New York Times Company