Both houses of the New York State Legislature have now approved a bill expanding the share of public pension funds that can be invested in complex, high-risk alternative assets such as private equity and hedge funds.

Wednesday’s vote in the Assembly was 121-15 in favor of the measure raising, to 30 percent from 25 percent, New York’s statutory “basket clause” cap on alternative investments. The state Senate approved the bill this morning (Thursday), but the vote tally and roll call was not immediately available.

Anxious to earn their assumed returns of 7 to 8 percent a year, pension funds across the country have been pushing more money into alternatives instead of traditional stocks and bonds. In the Empire State, the push for alternatives was spearheaded New York City’s pension funds, with the backing of Comptroller Scott Stringer.

The main argument in favor of alternatives is that they can deliver higher gains over the long term. However, as the Pioneer Institute’s Iliya Atanasov wrote yesterday at Manhattan Institute’s PublicSectorInc:

These days, alternative asset classes are so crowded with institutional investors hunting for a higher return that the true opportunities are likely either out of reach or too expensive. According to a recent Pew study, alternative allocations ballooned from 11 to 23 percent of public pension plans’ assets between 2006 and 2012. Many pension funds have been paying high fees for mediocre returns, often increasing rather than reducing their exposure to market risks.

Hedge funds did better than stocks but still took a beating during the financial crisis. Overall, the industry has underperformed broad market indices for over a decade, even before accounting for its rich fees and expenses. Preeminent managers such as George Soros have been closing their funds for new investments.

Most problematically from a public finance perspective, the alternatives space is, in general, opaque and the assets are very hard to value. These features make it easier for both pension funds and their private investment managers to engage in creative accounting.

The trustees of the city’s largest fund, the New York City Employee Retirement System (NYCERS) first called for a legislation expanding the alternatives basket back in the spring of 2013 — a move immediately denounced by former NYCERS executive director John Murphy. He wrote on his blog:

This is a stupid and dangerous idea. Without a legitimate oversight of the trustees’ investment decisions and performance the legislature in Albany should under no circumstance increase the trustees ability to make bad decisions. The trustees suffer no penalties for their mistakes, only the members, retirees, and the taxpayers of New York City get hit with the losses.

On their own public pension trustees are not capable of investing anything, period. You must always keep this in mind when evaluating the investment decisions that they make.

What the trustees are proposing is similar to a coach of basketball team that hits 10% of their 3-point shots and 50% of their 2-point shots trying to get his team to score more points. So he tells the team to [shoot] more 3-point shots and [fewer] 2-point shots. Guess what. The coach gets fired because the team loses, but not the trustees. No one knows whether they are winning or losing.

The original bill would have increased the maximum alternatives share to 35 percent, which had been requested by the city pension funds. Someone, somewhere in the Capitol, apparently decided this was excessive, and so the bill was amended just last week to adjust the maximum to 30 percent.  

At a time of the Assembly’s choosing, the bill will go the desk of Governor Andrew Cuomo.