investment strategy | Pension360

Fitch: Hedge Funds Will Continue “Winning and Keeping” Public Pensions Assets

Fitch Ratings predicts that, despite several high-profile exits by pension funds this year, hedge funds will continue to count public pension funds as major investors.

The ratings agency says exits by funds like CalPERS are “not representative of broader sector trends” and says it believes hedge funds still “deliver competitive returns net of fees, while providing a degree of downside protection and uncorrelated return during periods of stress”.

From Fitch:

Recent decisions by two large US public pension plans to pull back from hedge fund investments, and the likelihood of a sixth consecutive calendar year of return averages underperforming broad equity market returns, are not expected to curb investors’ overall allocations to hedge funds, according to Fitch Ratings.

Barring an unforeseen major market decline, hedge fund assets under management (AUM) should continue on a path toward $3.0 trillion, good growth relative to 2013’s year-end level of $2.6 trillion. The rise is attributable to market appreciation and inflows outpacing redemptions. The AUM flows show significant variation by strategy, with equity-oriented funds attracting more capital in recent periods, but global macro funds falling from favor.

While hedge fund growth has certainly slowed over the past several years, the high-profile pension plan withdrawals seen over the past six weeks are not representative of broader sector trends, in our view.

The Fitch report backs its conclusions with data from several studies conducted this year:

Fitch points to analysis recently compiled by Preqin as an indicator of the progress that hedge funds have made in winning and keeping US public pension assets more broadly. The data generally shows improvements in hedge fund investment allocations by public pensions since 2010. As of June 2014, 269 public pensions in the US made allocations to hedge funds, with an average of about 8.6% of their total AUM allocated to hedge funds.

[…]

Over the past decade and a half, hedge funds have delivered steadier performance relative to the overall market during bear markets, as was seen in 2000 to 2002 and in 2008. This downside protection, however, comes at the expense of limited upside during bull markets, a trend seen in 2003, 2009 and especially 2013.

According to Hedge Fund Research, hedge fund performance averages are set to be nearer to the broad equity market measures in 2014. However, trailing 36- and 48-month annual return levels generally range around low single-digit percentages, which paint the entire sector as under delivering relative to broader equity index benchmarks.

Read the full Fitch release here.

San Francisco Pension To Vote Again On Hedge Funds

The San Francisco Employees’ Retirement System is once again weighing whether to begin investing in hedge funds.

Last Spring, the fund formulated a plan to invest up to 15 percent of its assets, or $3 billion, in hedge funds. But the vote has been tabled three times since then.

This week, the fund will vote again on the issue.

From SFGate.com:

The board of the San Francisco Employees’ Retirement System is scheduled to vote Wednesday on a controversial proposal to invest $3 billion — 15 percent of its assets — in hedge funds. The system, which manages $20 billion in pension money on behalf of about 50,000 active and former city employees, has no hedge funds today.

[…]

A 15 percent allocation would definitely have an impact on the San Francisco pension fund. William Coaker Jr., who joined the system Jan. 30 as chief investment officer, wants to put 15 percent of its assets in hedge funds as a way to protect against a market correction. But some board members and pensioners see them as too expensive and risky.

[…]

Earlier this year Coaker and his staff, along with outside consultant Leslie Kautz of Angeles Investment Advisors, recommended investing 15 percent of the system’s assets in hedge funds as part of a realignment of its portfolio. The goal was to “reduce volatility in investment returns, improve performance in down markets, enhance diversification of our plan assets, increase the flexibility of the investment strategy, and to increase alpha (excess returns),” according to minutes of the June 18 meeting. Coaker did not return phone calls.

A vote on the measure was scheduled for October but shortly before the meeting, board President Victor Makras learned that Kautz’ firm has a fund of hedge funds registered in the Cayman Islands. “That was a material fact,” Makras said. “I continued the item and instructed the consultant to disclose that to my satisfaction.”

If the fund does vote to invest in hedge funds, there would be the following allocation changes, according to SFGate:

U.S. and foreign stocks would drop to 35 percent from 47 percent of assets. Bonds and other fixed-income would fall to 15 percent from 25 percent. Real estate would rise to 17 percent from 12 percent. Private equity would rise to 18 percent from 16 percent. And hedge funds would go to 15 percent from zero.

The San Francisco Employees’ Retirement System manages $20 billion in assets.

Louisiana Teacher’s Pension Defends Private Equity Investment With Carlyle

The New York Times recently obtained a copy of private equity limited partnership agreement that demonstrated how opaque the world of private equity is.

The agreement in question was for the Carlyle V fund – a fund that, as Pension360 covered, many public pension funds have invested in.

One such fund is the Teacher’s Retirement System of Louisiana, and it is now defending its private equity investments in light of the New York Times’ story. From the Baton Rouge Business Report:

The Teachers Retirement System of Louisiana…is responding to questions raised by a recent article in The New York Times about one of the private equity funds in which TRSL has invested.

The investigative report, published Sunday, details a “code of secrecy” it says exists between many large private equity funds and the state pension systems that invest in them. According to the story, pension systems are often hit with fees and the tab for hefty legal settlements incurred by the funds, without the knowledge of system members.

The story cites TRSL’s investment in the Carlyle V fund as one such example. It points to provisions in TRSL’s contract with Carlyle V that protects the fund’s partners from certain liabilities that investors—TRSL members—could ultimately have to pay.

TRSL defends its investment in Carlyle V, saying TRSL managers evaluate all investment opportunities and recommend investment only in funds with the best track records, terms and risk/return profiles.

“For the past 10 years, private equity investments have been TRSL’s highest performing asset class,” says Philip Griffith, TRSL chief investment officer. “Carlyle has been one of the system’s better-performing private equity funds.”

Griffith notes that TRSL’s total investment return in FY 2013 was 19.9%, the second-highest in the nation.

“Private equity returns were key to achieving this distinction,” he says.

State Treasurer John Kennedy, who sits on the TRSL board, declines to comment.

TRS Louisiana manages $17.5 billion in assets.

To read a copy of the Carlyle V agreement, click here.

Denmark Ramps Up Oversight Of Alternative Investments in Pension Systems

The entity that regulates Denmark’s financial system has announced plans to tighten oversight of alternative investments made by pension funds.

The move comes as regulators in the Financial Supervisory Authority have reported an uptick in risk, illiquidity and opacity in pension investments. From Bloomberg:

The Financial Supervisory Authority in Copenhagen will require pension funds to submit quarterly reports on their alternative investments to track their use of hedge funds, exposure to private equity and infrastructure projects. The decision follows funds’ failures to account adequately for risks in their investment strategies, according to an FSA report.

The regulatory clampdown comes as Denmark deals with risks it says are inherent to a system due to be introduced across the European Union in 2016. The new rules will allow pension funds to invest according to a so-called prudent person model, rather than setting outright limits. In Denmark, the approach has proven problematic for the only EU country to have adopted the model, said Jan Parner, the FSA’s deputy director general for pensions.

“The funds are setting up for their release from the quantitative requirements, but the problem is, it’s not clear what a prudent investment is,” Parner said in an interview. “The challenge for European supervisors is to explain to the industry what prudent investments are before the opposite ends up on the balance sheets.”

Denmark, which has almost two years of experience with the approach after its early adoption in 2012, says a lack of clear guidelines invites misinterpretation as firms try to inflate returns.

[…]

Danish funds and insurers have overestimated the value of alternative investments they made while failing to adequately account for the risks, the FSA said in a February report.

Pension funds held 152 billion kroner ($26 billion) at the end of 2012, or about 7 percent of their balance sheets, in equity stakes and other assets sold on markets the FSA characterized as illiquid, opaque and thin. The agency said they need to account better for those risks and ordered reports from the third quarter. PFA, Denmark’s biggest commercial pension fund, said today it invested in a shopping mall in western Denmark as part of a strategy to increase its presence in retail properties.

Denmark’s pension systems hold $500 billion in assets, collectively.

Photo: “Dannebrog”. Licensed under Creative Commons Attribution-Share Alike 2.5 via Wikimedia Commons

Arkansas Teacher’s Fund Fires PIMCO, Withdraws $475 Million From Firm

PIMCO's Newport Beach Office — PIMCO’s Newport Beach Office

The Arkansas Teacher Retirement System is pulling its money out of PIMCO, the fund announced today. Its investments with PIMCO had totaled $475 million.

Dan Primack: All Alternatives Are Not Created Equal

Pension funds have been receiving flak from all sides lately regarding alternative investments.

The criticisms have been varied: the high fees, opacity, underperformance and illiquidity.

But, outside of official statements from pension staff defending their investments, it’s not often we get to here from the people on the other side of the argument.

Dan Primack argues in a column this week that not all alternatives are created equal—and the fight against the asset class has been “oversimplified”.

From Fortune:

Hedge funds are considered to be “alternative investments.” So is private equity. And venture capital. And sometimes so is real estate, timber and certain types of commodities.

A number of public pension systems have increased their exposure to “alternatives” in recent years, at the same time that they either have curtailed (or threatened to curtail) payouts to pensioners. The official line is that the former is to prevent more of the latter, but many critics believe Wall Street is getting rich at the expense of modest retirees.

The complaint, however, generally boils down to this: Alternatives have underperformed the S&P 500 in recent years, even though many alternative funds charge higher fees than would a public equities index fund manager. In other words, state pensions are overpaying for underperformance.

Great bumper sticker. Lousy understanding of investment strategies.

The simple reality is that not all alternatives are created equal. Some, like private equity, are more tightly correlated to public equities than are others. Some are designed to chase public equities in bull markets without collapsing alongside them (that’s where the name “hedge” name from). Real estate is largely its own animal. Same goes for certain oil and gas partnerships.

Lumping all of them together because of fee strategies makes as much sense as arguing that a quarterback should be paid the same as an offensive lineman. After all, they both play football, right?

Primack uses New Jersey as an example:

For those who want to criticize public pensions for investing in alternatives, be specific. New Jersey, for example, reported alternative investment performance of 14.21% for the year ending June 30, 2014. That trailed the S&P 500 for the same period, which came in at 21.38% (or the S&P 1500, which came in at 16.99%). But that alternatives number is a composite of private equity (23.7%), hedge funds (10.2%), real estate (12.74%) and real assets/commodities (6.12%). The sub-asset class most tightly correlated to public equities actually outperformed the S&P 500 (net of fees).

Would New Jersey pensioners have been better off without private equity? Clearly not for that time period. Having avoided real estate or hedge funds, however, would be a different argument. But even that case is tough to prove until New Jersey’s relatively immature alternatives program experiences a bear market. For example, both hedge funds and the S&P 500 went red last month, but the S&P 500’s loss was actually a bit worse. And macro hedge fund managers actually had positive returns. Does that make up for years of the S&P 500 outperforming hedge? Likewise, should real estate performance receive an indirect bump from recent rises in venture capital performance, just because they are both “alternatives?”

Again, that’s a judgment call that should be based on voluminous data, rather than on knee-jerk anger that alternative money managers are getting paid while retiree benefits are getting cut. If alternative managers are helping to stem the severity of those cuts, then everyone wins. If not, then the state pension needs a change in policy. But, in either case, the specific alternative sub-asset classes should be analyzed on their own merits, rather than as one homogeneous bucket. Otherwise, critics may throw out the baby with the bathwater.

Read the entire column here.

Photo by 401kcalculator.org

The Case Against London Mayor’s Pension Proposal

London Mayor Boris Johnson wants to merge the country’s 39,000 public sector pension plans into one scheme, which would invest in building and updating the UK’s roads, airports, railroads and other infrastructure.

Yesterday, one of the UK’s largest pension funds, the London Pensions Fund Authority (LPFA), backed the idea.

But Sean O’Grady, economics editor of the Independent, offered a counter-point recently in his column. The bottom line, he says: “Sensible pension fund managers do not send their money where politicians tell them to.” From the column:

What most sensible pension fund managers do not do is send their cash to where politicians tell them to. If they do invest in the public sector, via PFI schemes, they do so via specialist companies and private equity vehicles who have worked out how to make money out of running prisons or trains. They do not do so directly.

There are good reasons for this. Let us take a few examples from history, “investment opportunities” presented as safe, prudent and lucrative ventures that successive governments poured taxpayers money into. The Millennium Dome; The Humber Bridge; Concorde; the NHS IT project; all vastly over budget, and an utter waste of money.

Or the Advanced Passenger Train and its unique “tilt” mechanism; cost £150m and never carried a single fare. Any and every block of 1960s high-rise flats that has since had to be dynamited, though the local authorities who built them are still paying off the debt. Nuclear power stations that promised electricity that would be too cheap to bother metering. Not to mention Boris’ glass testicle, by which I mean City Hall, as it has been renamed with cruel cockney humour.

Now of course there are worthy public projects that can earn a return for investors. The point is that the best people to decide on whether to invest your hard earned cash into such schemes are not the politicians who would like to get some votes off the back of them, but the investment managers we appoint to look after our cash. Private or public sector, would you really lend Boris Johnson your life savings so he can run a tube line to Bromley? I thought not.

The Mayor originally proposed his plan in a weekend op-ed in the Telegraph, which can be read here.

Pennsylvania Pension Chairman Defends Hedge Funds; Says “Strategy Is Working”

Pennsylvania’s top auditor has publicly wondered whether Pennsylvania’s State Employees Retirement System (SERS) should be investing in hedge funds.

SERS has released formal statements defending their investment strategy, which currently allocates 6.2 percent of assets toward hedge funds.

But today, we got the pension fund’s most in-depth defense yet of the asset class.

Glenn E. Becker, chairman of the SERS Board, wrote a letter to the editor of the Patriot News which was published today in the paper. The letter, in full, reads:

I feel it is important to correct the record and explain how our hedge fund exposure has been working for the state’s taxpayers.

Industry experts generally agree that while hedge funds are not for every pension system, the unique needs of each system must shape their individual asset allocation and strategic investment plans. Therefore, the actions taken by one system may not be appropriate for all systems. Investors need to consider many factors including their assets, liabilities, funding history, cash flow needs, and risk profile.

Our current plan was designed to structure a well-diversified portfolio to meet the needs of a system that is currently underfunded, steadily maturing (has more retirees than active members) and, in the near term, will receive employer contributions below the actuarially required rate.

Those unique characteristics mean we need liquidity, low cash flow volatility, and capital protection. We must plan to pay approximately $250 million in benefits every month for the next 80-plus years. We continuously monitor fund performance, the markets and cash flows for any needed plan adjustments. At this time, our plan uses hedge funds as an integral component of a well-diversified portfolio that is expected to provide risk-adjusted returns over all types of markets.

To date, the strategy has been working. As of June 30, 2014, our diversifying assets portfolio, or hedge funds, made up approximately 6.2 percent of the total $28 billion fund, or approximately $1.7 billion. In 2013, that portfolio earned 11.2 percent or $197 million, after deducting fees of $14.8 million, while dampening the volatility of the fund. That performance helped the total fund earn 13.6 percent net of fees in 2013, adding more than $1.6 billion to the fund.

Certainly, caution is warranted when examining one short period given SERS’ long-term liabilities. Over the long term, as of December 31, 2013, the total fund returned an annualized, net of fees return of 7.4 percent over 10 years, 8.4 percent over 20 years and 9.7 percent over 30 years.

Over the past 10 years, more than 75 percent of the funds’ assets have come from investments. In terms of making up for the past underfunding, that is money that doesn’t have to come from the taxpayers.

San Diego Pension Trustees React To Retainment of Controversial CIO

The San Diego County Employees Retirement System (SDCERS) voted 5-4 last week to retain its controversial CIO, Lee Partridge.

The vote was close, and nearly every trustee had something to say about the decision. From Bloomberg:

“All the sudden we found out we have $22 billion in exposure,” [trustee Dianne] Jacob said by telephone prior to the vote. “That should have never happened. The process is flawed. The hiring of Partridge in the beginning was flawed. Let’s get back to basics.”

[…]

“This is an exorbitant amount of taxpayer dollars being spent and is unprecedented in any other county in California,” [County Treasurer and trustee] McAllister said by e-mail before the vote. “I have strongly opposed the adoption of an outsourced government structure.”

McAllister went on, according to the San Diego Union-Tribune:

“The CEO, Brian White, has put SDCERA in the spotlight for all the wrong reasons,” said County Treasurer Dan McAllister, who serves on the pension board as part of his elected duties. “This is not the behavior we should expect from the CEO of one of the largest public pensions in the state.”

Those trustees were echoing the sentiment of city employees, many of whom had shown up to previous board meetings or written the trustees to express their insecurity with the pension fund’s investment strategy. From the San Diego Union-Tribune:

“You have a responsibility to represent hard-working San Diego County employees,” county employee Tracey Carter, a member of Service Employees International Union 221, told the board prior to the vote. “We have done our due diligence. We have separated headlines from facts. It is time to change direction with the management of the fund.”

But the majority of trustees voted not to fire Partridge. From the San Diego Union-Tribune:

“For those who continue the fear-mongering, shame on you,” said [trustee and board vice-chairman David] Myers.

More of Myers’ reaction from Bloomberg:

“Going forward with the contract is in the best interest of this organization and its members — it saves money,” David Myers, the board’s vice chairman, said at a Sept. 18 meeting. “The dysfunctionality of what is going on right now is, in my opinion, a breach of our responsibility to this organization.”

Salient Partners LP, the firm that employs Partridge, released this statement to Bloomberg:

“ [We] delivered $4.4 billion to SDCERA plan members at a lower cost and with less risk than 80 percent of similarly sized pension plans,” said Chris Moon Ashraf, a spokeswoman for the company at Jennifer Connelly Public Relations. “The average SDCERA plan beneficiary realized more than $111,000 in gains under Mr. Partridge’s stewardship for a total fee over five years of $414.”

The fund’s investment strategy was controversial because the CIO was allowed to use up to 500 percent leverage on certain parts of its portfolio, without seeking approval from the board or the fund’s director.

SDCERS returned just over 13 percent in 2014.

San Diego Fund Votes 5-4 To Retain Controversial CIO

After a “tense” five-hour deliberation, the Board of the San Diego County Employees Retirement Association (SDCERA) voted 5-4 to retain its outsourced chief investment officer.

The pension fund and its CIO, Lee Partridge, have made headlines in recent months due to their high tolerance for risk and extensive use of leverage.

From Chief Investment Officer Magazine:

The board of the San Diego County Employees Retirement Association (SDCERA) declined to terminate its contract with outsourced-CIO Salient Partners at a meeting on Thursday.

As predicted by those close to the $10 billion fund, the vote came down to the wire. After nearly five hours of discussion, a motion brought by trustee Dianne Jacobs to fire Salient was blocked by five trustees, including Chairman Skip Murphy, and backed by four.

Several stakeholders presented formal recommendations about the action before the board’s vote. The majority of these representatives urged the fiduciaries not to reverse their course—a risk-parity oriented portfolio overseen and invested by Salient.

“We believe your board is at a serious juncture,” said Susan Mallett, president of the county’s retired employee association. “You are suddenly and unexpectedly considering a reversal from an investment strategy you had agreed on after years of considered discussion. As a representative of thousands of members who absolutely depend on their pensions, I have received as many worried letters about leverage as I have about the actions of this board.”

Though the majority of trustees opted not to vote for a firing, the minority was very vocal during the meeting. From the San Diego Union-Tribune:

“The CEO, Brian White, has put SDCERA in the spotlight for all the wrong reasons,” said County Treasurer Dan McAllister, who serves on the pension board as part of his elected duties. “This is not the behavior we should expect from the CEO of one of the largest public pensions in the state.”

Dianne Jacob, chairwoman of the Board of Supervisors, made a motion to terminate the Salient contract early in the meeting.

“It’s time to steer things back to the basics of simplicity and common sense not because we have received criticism but because it’s the right thing to do for retirees and taxpayers,” Jacob said.

Jacob received the support of only three of her colleagues on the nine-member SDCERA board — Samantha Begovich, Mark Oemcke and McAllister. Five votes were required to terminate the contract.

Begovich, a prosecutor who recently joined the board, used the strongest language against the consulting firm, saying it has taken advantage of the pension system and has a stranglehold on more than $10 billion of public funds. She said supporters of the firm for years have presented one-sided information about the wisdom and soundness of its investment approach. She called the firm poisonous for San Diego County.

The Board did express the desire to gradually unwind its contract with the CIO and directed its staff to come up with some options for taking control out of the hands of Lee Partridge.

Those options will likely be presented at next month’s board meeting.

Photo by Keith Ivey via Flickr CC License

Deprecated: Function get_magic_quotes_gpc() is deprecated in /home/mhuddelson/public_html/pension360.org/wp-includes/formatting.php on line 3712