To hedge or not to hedge?

by E.J. McMahon |  | NY Torch

Stock_ticker-150x150The $300 billion California Public Employees’ Retirement System (Calpers), America’s largest public pension fund, is eliminating its $4 billion stake in hedge funds due to their “complexity, cost, and the lack of ability to scale,” the fund’s interim chief investment officer has just announced. But the $180 billion New York State and Local Retirement System (NYSLRS), the nation’s second largest public pension fund, seems poised to move in the opposite direction.

A bill passed by the Senate and Assembly at the end of their session in June would expand, to 30 percent from 25 percent, the share of pension fund investments that can be allocated in “baskets” of assets not otherwise specifically permitted by law. These include hedge funds and private equity funds, which involve more complex financial risks and are more difficult to value and monitor than traditional stocks and bonds. The change has been supported in the past by Comptroller Thomas DiNapoli, NYSLRS’ sole trustee, although the lobbying effort for the bill this year appears to have been spearheaded by the New York City pension funds.

The bigger-basket pension bill hasn’t yet been sent to Governor Andrew Cuomo for his signature. If his approval or veto message contains so much as a single sentence’s worth of substantive explanation, it will exceed the sum total of all public comment devoted to the subject by state lawmakers this year. (The issue has also gone virtually unnoticed by State Capitol news media.)

In fiscal 2007, when DiNapoli became comptroller, NYSLRS paid out $162 million of investment management fees, including $27 million for alternative investments. By fiscal 2013, the latest year for which data are available, investment fees had risen to $454 million, including $163 million in the “absolute return” category alone, which includes hedge funds.

Total NYSLRS assets in the alternative category came to 11.8 percent last year, including 3.2 percent invested in absolute return strategies. However, according to its annual report, the fund’s long-term goal is to increase its alternative allocation to 21 percent, including 10 percent in private equity and 4 percent in absolute return assets including hedge funds, plus 4 percent in the newer category of “opportunistic” investments and 3 percent in “real assets” including commodities, infrastructure and timberland meant to create “inflation hedging strategies,” the annual report said.

And speaking of pension fund assets, DiNapolio last week announced what he described as a “$2 billion strategic partnership with Goldman Sachs Asset Management (GSAM) to invest in a diverse group of global equity strategies viewed as having strong potential to enhance the Fund’s return.” Goldman also is supposed to “provide strategic advice across the entire equity portfolio,” assigning more than 300 managers to this task. What’s Goldman’s cut? Neither the comptroller’s office nor Goldman would offer specifics, although a DiNapoli spokesman was quoted as assuring the New York Post that the fees would be “very reasonable.”

Aaron Elstein of Crain’s NY Business deciphered the deal announcement here. Referring to a line in the comptroller’s news release, Elstein observed:

“Dynamic manager selection opportunities” is gibberish that in its tortured way means Goldman will introduce the pension fund to money managers who aim to outperform the market. 

Wish everyone luck on that one. Most active money managers over time don’t beat the market.  Hedge funds, for instance, have performed worse than a plain old S&P 500 index fund for several years.

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- E.J. McMahon is the Research Director at the Empire Center for Public Policy.