Hedging bets on Hedge Funds
By Kenyon Farrow
While other public pension funds dove head first into the murky pool of hedge fund investments, New York City studied the waters.
Now, the city may finally be ready to stick in its big toe.
Anxious to curb ever-shrinking pension returns, Comptroller William Thompson, Jr. (D) announced in January that the public pension boards were one step closer to investing a portion of their money in hedge funds, as part of an entire plan to help diversify portfolios which total nearly $100 billion in assets.
“Look how much the city puts in pensions right now,” Thompson said. “A lot of it is because the stock market was down three years in a row.”
According to Thompson, the city pours in $4 billion each year to fill the gaps the pension investments did not cover for the 237,000 retirees and beneficiaries who rely on them.
“Our returns have been good, but not as good as we’d like,” said City Finance Commissioner Martha Stark, who also chairs the New York City Employee Retirement System (NYCERS).
NYCERS, one of the five major city pensions, approached Thompson’s office nearly two years ago, searching for ways to get better returns on the investments for the 344,000 total city employees who currently pay into the system.
Each board is financially independent, and has a separate board of trustees made up of representatives from the city and labor unions. Each has an independent investment consultant.
Last year, San Diego County’s experiment with hedge fund investing cost its pensions $87 million, when its hedge fund, Amaranth, bet heavily on natural gas and lost over 65 percent of its total assets.
“Each board has its own personality,” explained Joseph Haslip, executive director of pensions with the Comptroller’s Office.
Thompson serves as an advisor to all of the pension boards. He and his staff began conducting educational sessions for the boards on other investment strategies. The controversial hedge fund investments were one of the strategies discussed.
“After learning about hedge funds, several expressed no interest, and some decided they wanted to learn more,” said Haslip.
Those concerns were echoed by DC 37, one of the labor unions with a seat on the NYCERS board.
Mike Musaraca, the union’s assistant director of research and negotiations, emphasized how cautiously they have moved in their decision-making.
“Given the concerns, we have a responsibility to do our due diligence,” he said.
Once primarily an investment strategy for wealthy individual investors, hedge funds became popular for public investments after the Sept. 11 attacks. During the stock market slump which followed, they provided new ways for pension funds to stem their losses, if not gain huge profits.
Since 2005, public pension investment in hedge funds increased by 66 percent, according to Greenwich Associates, an investment consulting firm in Connecticut.
Still, hedge funds do have some complications, including their relationship with the Securities & Exchange Commission (SEC), that make some investors leery.
“There is no regulatory framework for hedge funds,” said M. Suresh Sundaresan, a professor of economics and finance at Columbia University’s Business School. “They don’t report to the SEC on a regular basis.”
In short, hedge funds are not mutual funds, which invest for the long haul. Hedge funds use both long and short term investment strategies, in order to try to quickly buy “hot” investments or to dump “cold” ones.
But jumping on the next hottest investment can prove fatal—either through bad management, bad investments, or both.
Last year, San Diego County’s experiment with hedge fund investing cost its pensions $87 million, when its hedge fund, Amaranth, bet heavily on natural gas and lost over 65 percent of its total assets. This followed excellent initial performance, with Amaranth up 30 percent during the first 10 months of the investment.
When and if a public pension fund loses money, those losses must be integrated into the local government’s budget. Taxpayers are then forced to make up these losses out of funds set aside for other projects or public services.
Several city officials said that if any of the pension boards decide to invest in hedge funds, they may start off small. They quoted investment figures between 1 and 5 percent of total assets. Once the pension boards invest, there are other ways to manage the risk involved. (By comparison, San Diego County had 20 percent of their $7.7 billion in assets invested in hedge funds.)
“Over time, you can increase or decrease your investment,” said Sundaresan, of Columbia. “If you are actively managing the hedge funds, then you may be able to be successful.”
Because of the potential for abuse, Haslip said the city’s pension boards are already planning to look closely at hedge funds that have achieved greater transparency by producing quarterly reports and benchmarks for investors.
Based on these documents, industry associations rank the performance of hedge funds and their managers.
“The more public pension funds get involved, the more transparent hedge funds have gotten,” noted Thompson.
The comptroller’s office will be making a presentation to the boards in coming weeks. The boards will make decisions on the investments later this year. Boards which choose to invest in hedge funds will hire specialty consultants, independent of their investment consultants, to advise them on which funds are performing well, and how much should be invested.
Haslip said New York’s pension boards did the smart thing to avoid a similar catastrophe by treading lightly into the new investment strategy.
“I think it’s good that we didn’t rush in,” he said. “We waited and learned from the successes and mistakes of our colleagues across the country.”
