hedge funds – RI Future

September 28, 2016September 28, 2016

Back to basics: RI will switch from costly, risky hedge funds

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When Seth Magaziner ran for General Treasurer in 2014, he promised that his top priority would be putting Rhode Island’s ailing pension funds in a better position by securing higher returns on investment at the lowest practical risk.

I spoke to Seth this afternoon about his new plan for the pension funds which was unanimously approved today by the State Investment Commission.

The state’s public pension funds currently hold around $7.6 billion of which about $1.1 billion has been invested in so-called “hedge funds” that were originally intended to provide investors with good returns and security.

However, as numerous reports have shown, hedge fund performance hasn’t matched hedge fund promises, except perhaps for their managers who have become billionaires while handling other people’s money.

Searching for alternatives, the Treasurer’s office conducted months of research and consultation with financial experts. They also ran “thousands of models and projections” to come up with a better way to get better returns on investment without undue risk.

The result was announced by Seth today – a “Back to Basics” plan to move about half of the money the state has invested in hedge funds – around half a billion dollars – into safer, better investments such as low-fee index funds.

This will take place over the next two years.

I asked Seth to talk about the challenges of coming up with such a plan, such as public impatience with the pace of change.

“When you’re moving this much money,” he said, “You have to do it in an orderly fashion.” He said making such changes was “like steering an aircraft carrier – you can’t turn on a dime.”

Then there is the matter of exit fees involved when leaving investment vehicles such as hedge funds. “We wanted to make sure we avoided early redemption fees” which in some cases could be significant.

The other factor requiring a careful, deliberate approach is the need to find solid investment alternatives.

I told Seth that the dream of many people, me included, is to see pension fund money used to create local jobs and businesses. But I acknowledged the fact that pension law doesn’t really allow that to be a major pension fund priority.

Seth pointed out that the first duty of any pension trustee is to secure the best rate of return for beneficiaries with the least risk.

That said, among the alternatives they’ve explored are funds that invest in infrastructure. He noted the infrastructure investment market is very “hot” at the moment so the cost of buying in is high. Of course, the basic rule of investing is “buy low, sell high” not vice versa, so timing is a key issue.

Rhode Island has used its pension funds’ proxy voting rights to join with other public pension funds around the country to support shareholder resolutions against excessive executive pay and other abusive corporate practices. These pension funds control millions of shares so they carry some weight at corporate annual shareholder meetings.

The state pension fund is no longer in crisis as it was six years ago. Since Seth took office two years ago, the fund has run in the black for the two years, earning more than $390 million and beating the fund’s goal.
Rather than give back so much to hedge funds, the “Back to Basics” plan should reduce costs while boosting earnings while taking a cautious, prudent approach to risk.

August 9, 2016

Hedge funds continue to hamper RI pension fund

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Click on the image to learn more about the Rhode Island Retired Teachers' Association. — Click on the image to learn more about the Rhode Island Retired Teachers’ Association.

Rhode Island’s pension fund lost money for the second straight year because of the hedge fund gamble Governor Gina Raimondo made when she restructured the system as the state’s general treasurer in late 2011.

“This is precisely what we predicted four years ago,” public pension expert Ted Siedle told Jim Hummel on WPRO recently.

The pension fund fell 5.9 percent – or $466 million – thanks in large part to a 6.94 percent decline in hedge fund assets.

Along with switching from a defined benefit-type pension to a defined contribution-style plan, the investment in hedge funds was the most controversial component of Raimondo’s plan to overhaul the state pension system. Siedle told Hummel, “The gamble has not paid off. It has been a massively costly gamble for taxpayers.”

According to Siedle, investments in hedge funds have cost Rhode Island $2 billion since Raimondo revamped the pension plan in late 2011, or $4,000 per taxpayer. Meanwhile, California, the largest public pension plan in the US, has stopped investing in hedge funds and New Jersey has taken $9 billion out of hedge funds. “But in your state,” Siedle said, “the losses continue to mount because of this reckless gamble that Gina Raimondo began and Seth Magaziner has continued.”

Siedle said the continued investment in hedge funds could have more to do with campaign contributions than pension solvency.

“This is a politically motivated decision to invest in hedge funds,” Siedle told Hummel. “This is about campaign contributions, this is about politics. This is not about investment theory or investment philosophy. You’ve got terrible performance but massive political donations. You figure it out.”

May 9, 2016

New York and California divested pensions from hedge funds, can RI?

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California, the state Gov. Gina Raimondo was visiting for a fundraiser to promote her pension policies, and New York have recently divested from high-risk, high-cost hedge funds like those the Rhode Island fund invests in.

One New York City official in an April 14 Reuters story said of hedge fund managers, “Let them sell their summer homes and jets, and return those fees to their investors.”

The board of the New York City Employees Retirement System (NYCERS) voted to leave blue chip firms such as Brevan Howard and D.E. Shaw after their consultants said they can reach their targeted investment returns with less risky funds. The move by the fund, which had $51.2 billion in assets as of Jan. 31, follows a similar actions by the California Public Employees’ Retirement System (Calpers), the nation’s largest public pension fund, and public pensions in Illinois. “Hedges have underperformed, costing us millions,” New York City’s Public Advocate Letitia James told board members in prepared remarks… NYCERS had $1.7 billion invested in hedge funds at the end of the second quarter 2015, according to its financial report. That amounted to 2.8 percent of total assets and was the smallest portion of its ‘alternative investments’ portfolio, which included $8.1 billion in private equity.

This begs the question: when will General Treasurer Seth Magaziner do likewise?

To help me parse through this further, Ted Siedle, who is now working on his third forensic audit of the pension, this time dealing with the real estate investment portfolio, sat down with me for an interview. He compared the pension scheme to “nothing Buddy Cianci would have ever dreamed of.”

Click the player below to listen to my full interview with Siedle

“My sense is that, from some some comments I have seen attributed to Seth Magaziner, is that he is preparing to distance himself from at least the Governor’s hedge fund gamble with pension assets. So it appears that he is moving from a ‘stay-the-course and incrementally fire poor performing hedge fund managers and replace them with promising hedge fund managers and make the case that the good outweighs the bad’, moving to an approach where he says either he will abandon the hedge fund strategy altogether or, going forward, or he will jettison perhaps half of the hedge funds and keep the remaining.

Siedle added, “But I think he’s making noises like he may make a bolder move to distance himself from the investment strategies that the Governor implemented. I think that Magaziner is heading in a better direction. I am not hearing a clear indication that his predecessor was wrong about anything and his predecessor was wrong… The massive benefit cuts and the massive investment in speculative hedge funds, high-risk high-cost hedge funds and private equity funds, was a foreseeable disaster, it was foreseen by me, I wrote about it before the strategy had been even fully implemented. Warren Buffett warned this was something that should not be done.”

Projected savings from pension cuts could soon be evaporated by poorly performing hedge funds, Siedle said.

“The benefits were cut to save $2 billion over the next twenty years. Within four or five years … the pension’s lost probably about $2 billion. So all of the projected savings have been, I suspect … will have been eliminated by foreseeable losses. So this has been probably the most disastrous investment decision ever made in the history of Rhode Island.”

He said, “So what I would submit a responsible, courageous State Treasurer would do would to be to call out that this was a horrific mistake, but I’m not hearing that. I’m hearing a distancing but not a mature, responsible response.”

To further clarify what Siedle feels about Magaziner’s time on the job, just look to his recent writings for Forbes:

At 31, Magaziner—lacking any meaningful investment experience—somehow convinced voters in 2014 that he could competently oversee the massively underfunded, embattled $7 billion state pension. Talk about chutzpah—a kid whose personal income the year before assuming office was reportedly approximately $5,183 (yet he somehow loaned his campaign $550,000)… Not only has Magaziner failed to follow through on his transparency promises, despite five years of dismal hedge fund performance at the pension he oversees, he remains committed to Governor Raimondo’s secretive, costly deal with Wall Street.

January 8, 2016

David Sirota goes after Raimondo on hedge funds with new allegations

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It’s a new year, so there’s a new piece by International Business Times‘ senior editor for investigations, David Sirota, taking on Gina Raimondo‘s dismal record in pension reform. This piece isn’t getting a lot of attention locally, which is a shame because it actually explains the pension reform/hedge fund situation quite nicely. The accepted story among the most politicians is that pension reform was necessary. As Gina Raimondo said in the Wall St Journal (quoted in Sirota’s piece) “Don’t be mad at me. Be mad at people who made promises that were unaffordable.”

However that may be, we certainly didn’t need pensions locked into hedge funds that have, notes Sirota, “generated big revenues for Wall Street firms, but only middling returns for a $7.6 billion pension fund on which more than 58,000 current and future retirees rely.”

When retiree Diane Bucci and others began to dig into the poor performance of the hedge funds, “they learned of a federal review showing that roughly half of all private equity firms are charging hidden fees, and they saw a hedge fund industry whose returns have failed to keep pace with the stock market. When they dug deeper, they stumbled onto an even more disturbing revelation. What they found, they say, is evidence that some investors can obtain special rights that may let them secretly siphon money from the state pensioners’ retirement savings.”

Here’s the link to the full story, well worth a read:

Wall Street Fine Print: Retirees Want FBI Probe Of Pension Investment Deals

April 30, 2013April 30, 2013

What RI should know about hedge funds, part 2

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The truly remarkable thing about the hedge fund industry is that once you strip away the confusion about how shares are valued and what exactly the returns are, you find returns that are far from extraordinary. In fact, the average returns over the past 20 years for the industry — the returns actually experienced by the vast majority of hedge fund investors — are less than they would have earned in government bonds. (And this isn’t just a matter of the huge losses in 2008-2009, though obviously that didn’t help.) This isn’t to say that some customers aren’t lucky in their choice of funds, but the odds are stacked heavily against them.

As if this isn’t bad enough, fraud in the hedge fund industry is hardly confined to Bernie Madoff. The unregulated and opaque nature of the funds lends itself to fraud. Plenty of managers have succumbed to the obvious moral hazard, and Simon Lack, in his book, “Hedge Fund Mirage: The Illusion of Big Money and Why It’s Too Good to Be True“, provides plenty of examples. With a hedge fund, the entire investment is at risk, so fraud is an ever-present concern.

The Hedge Fund Fraud Casebook provides over 100 examples of hedge fund fraud, all of which happened before anyone realized that Bernie Madoff, the former president of the NASDAQ and famous fund manager, was running a giant Ponzi scheme, but also before the frauds of Conrad Seghers, James Dickey, Ed Strafaci, Mark Focht, Paul Eustace, Michael Berger, and many more were uncovered. When the industry standard is to charge high fees and to tell your customers what you want and when you want, can any of this be a surprise?

Surveying the industry landscape at the end of his book, Lack says he used to blame the managers for running a rigged game, but eventually he turned around and now blames the customers for enabling this bad behavior. This is a funny kind of Wall Street blame-the-victim ethics, but it is true that a lot of institutional investors — like pension funds — have the resources to have discovered these facts on their own. And they haven’t.

Let’s be clear: any investment portfolio should be hedged somehow. Even within the world of stocks, most fools know you don’t make a portfolio out of a single company’s stock. Diversifying stocks is one way to hedge. Diversifying investments so that you’ve got some money in things that tend to go up in value when your other investments go down is also wise. This is what hedge funds originally did. But the evidence implies that the lowest cost way to do that now might be to do it yourself. Want to hedge your exposure to stocks with investments in bonds? Go find a friendly bond dealer and buy some. Or invest in a mutual fund for bonds. Want to invest in failing mortgages? You can find ways to do that without paying 2-and-20. Gold? That can be done, too, if you must. But if you go to a hedge fund, you should know that you’re walking into a casino where the odds are great that you’re not going to walk out with nearly as much money as the advertising claims. If you walk out with any at all. The occasional lucky patsy can walk out of a rigged game a winner, but that doesn’t mean the game isn’t rigged. As they say in poker, if you can’t tell who’s the patsy at the table, well, you’re the patsy.

If you’re not a “accredited” investor, who can afford to dine at tables like these, why should you care? Because, though you might not be one yourself, you probably belong to one. Institutional investors — pension funds, university endowments, banks, charitable foundations — make up a huge proportion of the money invested in the hedge fund industry, though exact data is hard to come by. You probably have a piece of this somewhere, perhaps as a taxpayer whose municipal or state government is investing heavily in hedge funds, or as an alumnus/a of some college, or as a customer at a big bank. Rhode Island’s pension fund has increased its investment in hedge funds substantially, and as much as a quarter of the value of the fund is now invested in “alternative investments”, which includes hedge funds, and private equity funds (also not an industry known for its low fees and transparency).

The stated reason behind this is to increase the returns. This is important, as a result of the 2011 pension changes. With fewer people paying less money into the pension fund, investment returns are more important than ever before to make good the state’s debts to its retirees. Perhaps it’s possible to negotiate lower fees, or find ways to increase the transparency of the funds you invest in, but there are valid reasons to be very skeptical.

Here and in other states, when your money winds up in a hedge fund, the people in charge of your money have put it in the care of fund managers whose incentives do not involve keeping your best interests at heart. And while those Very Serious People invest your money in these risky and opaque funds, they are relying on the empty promises of representatives of a corrupt industry. If they do well, you’re lucky. If, as is more likely the case, they do not — well, you’re the patsy.

Part I of this series

Updated: clarified that the RI fund’s allocation to alternative investments is not exclusively hedge funds.