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US Pensions Squander Retirees' Cash On Fees For Underperforming Hedge Funds

Tyler Durden's picture




 

As you might be aware, America’s state and local governments are facing a series of fiscal crises that are inextricably bound to public sector pension funds. 

This is something we’ve spent quite a bit of time documenting over the years, and especially since May, when the Illinois State Supreme Court struck down a pension reform bid, triggering a Moody’s downgrade for the city of Chicago and thrusting the state’s budget crisis into the national spotlight. 

In October, Comptroller Leslie Geissler Munger admitted that Springfield would have to forego a $566 million pension payment in November. 

And it’s not just Chicago. There’s also Houston, where a $3.2 billion pension-funding gap imperils the city’s credit rating and threatens to hurt demand for the city’s debt. “Among other concerns, the city’s plans assume relatively high investment returns of 8% or above, meaning the funding gap may be understated,” Marc Watts, chairman of the Greater Houston Partnership’s Municipal Finance Task Force, told WSJ. “Yes, ‘relatively high investment returns,’ as in, ‘returns that in today’s world can’t possibly be generated by anything that even approximates a conservative mix of assets,’” we said.

This is a persistent problem with public pension funds. In order to keep the present value of the liability from ballooning, managers need to cling to a 7-8% return assumption. Of course in a NIRP world, that’s next to impossible to achieve unless you reach for yield by “diversifying” into riskier asset classes. Here’s a graphic from a 2014 report from a panel commissioned by the Society of Actuaries: 

As you can see, the percentage of funds dedicated to “alternatives” has risen steadily. Consider another chart, this one from Bloomberg which shows that pension funds have essentially doubled their allocation to hedge funds over the past four years: 

This is in part an effort to offset the inexorable declines in fixed income yields but regular readers will no doubt immediately identify the problem with this strategy. For those who need a reminder, here’s what we said in the wake of the flash-crashing nightmare that hit markets in late August: 

Incidentally, here’s what "hedge" funds should do: protect against massive, "fat tail" days like this Monday; instead they merely ride the beta train with the most leverage possible, hoping that the Fed will prevent any events that actually need hedging, and blow up in a fiery crash any time the market tumbles. Needless to say this makes most of them utterly useless, especially since one can just buy the SPY for almost nothing, and avoid paying the hefty 2 and 20 (or 3 and 45) fee.

Well, public sector pension fund managers have apparently been completely oblivious to that point for the better part of a half decade and as Bloomberg reports, it’s cost them dearly.  

“The investment pools gained 0.4 percent through November, putting them on pace for the worst year since 2011,” Bloomberg says, before reminding the world that these things are blowing up faster than an ISIS oil convoy caught in the crosshairs of a Russian Su-34. “The industry’s struggle was underscored over the past two months as BlackRock Inc., Fortress Investment Group and Bain Capital closed hedge funds after running up losses.”

Here’s more: 

The low returns are dealing a setback to governments that boosted exposure to hedge funds, seeking windfalls to help close a $1.4 trillion shortfall that’s facing public-employee retirement systems nationwide. The investment funds have underperformed stocks since 2008 as share prices rallied and volatility whipsawed global financial markets.

 

Public pensions count on investment returns of more than 7 percent a year, so anything less puts pressure on governments to set aside more to ensure they can cover all the benefits promised to employees.

 

With their investments faltering, funds with more than $16 billion of assets have announced plans to shut down this year, including those run by some of Wall Street’s most well-known firms, according to data compiled by Bloomberg. BlackRock decided to close its Global Ascent hedge fund following losses that triggered withdrawals by investors including the Arizona Public Safety Personnel Retirement System, Fort Worth Employees’ Retirement Fund and the Maryland State Retirement and Pension System.

 

The California Public Employees’ Retirement System, the U.S.’s largest public pension, said last year it would liquidate its $4 billion hedge-fund portfolio because of the cost and complexity.

Underscoring just how poorly these investments have performed especially considering the fee structure, Jeff Hooke, a managing director with Focus Investment Banking in Washington conducted a study with five state pension funds over five years which showed that the median return on hedge-fund investments a full 6 percentage points lower than a 60/40 equity-fixed income index fund managed by Vanguard. The expense ratio on the Vanguard fund: 0.23%. That’s a hell of a long way away from 2 and 20. 

Hooke’s conclusion: “Hedge funds have cost the states tens of billions in opportunity costs the last five years.” 

So amusingly, public pension funds probably could have closed their funding gap by just buying the S&P and watching the Bernanke/Yellen put work its magic, but instead, they went out and plowed retirees’ money into hedge funds that ended up massively underperforming and now, it’s too late to take advantage of the equity gravy train because the FOMC is about the yank the punchbowl. 

We hope someone has learned a lesson here, but we seriously doubt it, because as Donald Boyd, senior fellow at the Nelson A. Rockefeller Institute of Government told Bloomberg, the longer pension fund managers cling to unrealistic return assumptions in a ZIRP and NIRP world, the more they’ll reach and the more they’ll likely lose which means “taxpayers and those who count on government services and investments will pay the price.”

 

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Wed, 12/09/2015 - 15:36 | 6900679 NoDebt
NoDebt's picture

It's pretty easy to sell snake oil to desperate people.  Ooooh!  Look!  8% returns!  (disclaimer: your mileage may vary)  

 

You wanna duplicate hedge fund returns (exceed most of them, actually)?  Buy the S&P on as much leverage as you can lay your mits on.  Done.  No need to pay anyone 2-and-20.

Wed, 12/09/2015 - 15:37 | 6900691 venturen
venturen's picture

does that come with a strip club visit, a ski trip and a ticket to steak house...if not I am out! 

Pension fund manager!

Wed, 12/09/2015 - 15:47 | 6900726 homebody
homebody's picture

Just like the Cancer treatment place that shows healthy, happy people and then below in small print "you should not expect these results"

Wed, 12/09/2015 - 15:50 | 6900738 firstdivision
firstdivision's picture

This biggest lie to the american public was to put their earnings into the markets and not save.

Wed, 12/09/2015 - 15:54 | 6900757 NoDebt
NoDebt's picture

Most people don't even know what the difference between saving and investing is, let alone which one they should be doing in a given situation.

Wed, 12/09/2015 - 16:27 | 6900923 swmnguy
swmnguy's picture

Hell, most people don't know the difference between gambling and investing, either.

Wed, 12/09/2015 - 17:11 | 6901130 Mentaliusanything
Mentaliusanything's picture

Saving and investing in within a ZIRP framework is "pointless"

Wed, 12/09/2015 - 16:27 | 6900924 Falling Down
Falling Down's picture

I don't recall that there were people marching with torches and pitchforks in the 90's when Greenspan shoved interest rates down, and became famous for his 'puts'.

 

 

Wed, 12/09/2015 - 15:35 | 6900681 madbraz
madbraz's picture

if they'd bought long-term treasuries in the last 2 years, they would have made those returns.  unfortunately, hedge funds just short treasuries - dumba$$es

Wed, 12/09/2015 - 15:37 | 6900689 Seasmoke
Seasmoke's picture

The public parasites have killed the host. Sorry suckers. 

Wed, 12/09/2015 - 15:42 | 6900710 NoDebt
NoDebt's picture

In 10 years anyone uttering the phrase "but I was promised!" will get immediately jumped by the whole room like they had just mentioned black-on-black crime or some other taboo subject.

Wed, 12/09/2015 - 18:51 | 6901536 nosam
nosam's picture

These pension funds knew what they were getting into. The pension fund managers were probably bribed into buying hedge funds. Pensioners lost their pension to hookers and blow.

Wed, 12/09/2015 - 15:37 | 6900692 Bill of Rights
Bill of Rights's picture

The sick just got sicker

That Obamacare penalty will be bigger than you think

http://www.cnbc.com/2015/12/08/that-obamacare-penalty-will-be-bigger-tha...

Wed, 12/09/2015 - 16:24 | 6900902 TheDanimal
TheDanimal's picture

I love how they're suggesting people go to healthcare.gov to donate their personal information to a needy 3rd world cybercriminal...er I mean.. see if purchasing largely useless health plans could be cheaper than paying the largely useless tax penalty.

Thu, 12/10/2015 - 06:47 | 6903316 Refuse-Resist
Refuse-Resist's picture

Penalty Schmenalty.  $1450?  Shiver me timbers!

That's what I'm being asked to pay for 1 month of a bronze plan to cover 2 adults and 2 kids, with a $12,400 deductible, 88% higher than 2015, and 90% more than my mortgage.

You can't take what I don't have.

 

Wed, 12/09/2015 - 15:38 | 6900699 buzzsaw99
buzzsaw99's picture

it should be illegal for pension funds to buy junk or invest with hedge fund maggots.

Wed, 12/09/2015 - 15:38 | 6900700 Make_Mine_A_Double
Make_Mine_A_Double's picture

This is going to get really interesting for a state like Oygun whose public pension has a - guaranteed return - of something like 7 or 8% per year per the union contracts.

Being the state must cough up the differential if it doesn't. Not sure if that has been adjusted, but doubtful as the Hammer and Sickle still fly over city hall in Portland and Eugene.

Wed, 12/09/2015 - 15:52 | 6900717 NoDebt
NoDebt's picture

Take it while you can because it's not going to last.  I advise almost everyone to start their pension as soon as possible (if they have one, which nobody under 50 does), almost regardless of where the break-even point is on the payout.  

Wed, 12/09/2015 - 16:02 | 6900797 Quant Jockey
Quant Jockey's picture

The politics in Orygun is a case study for how not to run a state. Former Portlander here. I do not envy Mr. Wheeler. Look on the bright side. We're all comrads now. Forward, Soviet!

Wed, 12/09/2015 - 15:38 | 6900701 aliki
aliki's picture

if they were "hedge" funds, they'd be fine year-to-date

since they turned into "levered long mutual" funds, they are getting waxed

follow the heard, u get slaughtered

layer leverage on-top --- get douced with gasoline & a lit match as u walk into the glue factory

Wed, 12/09/2015 - 15:44 | 6900714 SharkBit
SharkBit's picture

Hedge Funds are a total scam.  Should be illigal.  2 and 20.  Bullshit.  All upside and zero downside.  Good book - Money Mavericks: Confessions of a Hedge Fund Manager

Wed, 12/09/2015 - 15:50 | 6900740 NoDebt
NoDebt's picture

The best part of the scam is that you have to be an "accredited investor" to invest in one.  NOBODY wants to be told "sorry, you can't come in this club."  They scratch and claw their way to get in just so they can be fleeced in fees for sub-par returns in up markets and magnified losses in down markets.

All you gotta do is tell people "you're not allowed to do this" and guess what?  They can't accept it.  They can't stop thinking about it.  They MUST have it.

Wed, 12/09/2015 - 15:54 | 6900760 homebody
homebody's picture

You had to beg Madoff to take your money

Wed, 12/09/2015 - 16:31 | 6900934 T-NUTZ
T-NUTZ's picture

yeah good idea, make them "illigal".  some of you people astound me with your stupidity and hypocrisy

Wed, 12/09/2015 - 15:47 | 6900719 SillySalesmanQu...
SillySalesmanQuestion's picture

Just another sophisticated method of the banksters stealing ALL they can by whatever means at their disposal. Take NoDebt's advice and get out what you can.....Aaaaannnnnnd, it's gone.

Wed, 12/09/2015 - 15:45 | 6900720 Bruce Gender
Bruce Gender's picture

But I was told that "buy and hold" was the only way to go! Are you saying the financial talking heads were lying to me?

Wed, 12/09/2015 - 17:18 | 6901162 surf@jm
surf@jm's picture

Nawwww....Buy and hold that stock, so, when the company prints twice as many shares, you lose half your face value......Just like Federal reserve Notes......LMAO!......

Wed, 12/09/2015 - 15:47 | 6900725 Kaiser Sousa
Kaiser Sousa's picture

and whatever u do u soon to be impoverished, gullible, ignorant of monetary affairs Ameridumbs - 

DO NOT BUY PHYSICAL GOLD OR SILVER!!!!!

Sincerely,

The MoneyChangers

Wed, 12/09/2015 - 16:28 | 6900926 T-NUTZ
T-NUTZ's picture

most.  short. gold. ever...

Wed, 12/09/2015 - 17:15 | 6901143 surf@jm
surf@jm's picture

Speaking of which....Is it me, or has anybody else noticed the price of physical precious metals at dealers, is not dropping with the quoted market price for gold and silver?.....I guess the naked shorting of paper silver and gold, is not working anymore to manipulate precious metal prices any lower......hummmmm......

Wed, 12/09/2015 - 15:51 | 6900744 Professorlocknload
Professorlocknload's picture

It will all be printed away.

Wed, 12/09/2015 - 15:55 | 6900763 GRDguy
GRDguy's picture

The Great Red Dragon, seeing that pensions wouldn't put all their funds into a small number of investment banks, created thousands of "dragonettes." Thus pension funds thought they were spreading their risks.  Actually, they were just putting money into 100s of firms controlled by the major firms.  For example, instead of just GS or JPM, they put their money with 100s of firms controlled by JPM or GS. (and others.)

Wed, 12/09/2015 - 16:05 | 6900807 PrimalScream
PrimalScream's picture

It's one of the greatest tragedies in American finance.  How the Pension Funds lost the savings of a whole generation of Americans .... the Baby Boomers.  That tragedy is still unfolding.  But the losses are "baked into the cake".  There are a lot of Americans who worked their whole life, people who couldn't understand money and trusted what their Pension managers told them.  They will lose everything. 

The vast majority of Pension Fund managers should never have been in charge of finance.  They "believed in the system", they did "what everybody else did in their game", and they collected good paychecks.

Wall Street saw the STING and played it for all that it was worth.

Unforgiveable. 

Wed, 12/09/2015 - 17:31 | 6901212 Clesthenes
Clesthenes's picture

Hey, we’re talking about pensions for State Bureaucrats, you know, police, inspectors, tax collectors and other members of useless and criminal classes.

These are people who spent their careers making life miserable for privately-employed taxpayers.

The least we could do for these officially-protected thieves is to organize a war crimes trial for them.

Wed, 12/09/2015 - 17:57 | 6901324 Jethro
Jethro's picture

I personally don't wish them any ill will. Cops have a pretty lousy job, and deal with complete shitheads on a daily basis. After 20-years of this, they'll have a PhD in crime. Nothing is more dangerous than a man with nothing left to lose. I'm not saying that anyone should change their feelings about this, especially in light of public sector pay exceeding private sector pay in the last decade (egregiously so), but realize that there will be some amount of "blowback"

Wed, 12/09/2015 - 16:28 | 6900925 T-NUTZ
T-NUTZ's picture

yeah blame the hedge funds and their fee structure, why not?

 

Wed, 12/09/2015 - 17:28 | 6901177 SweetDougisaTwat
SweetDougisaTwat's picture

Truth be told, there were, are, and always will be just a very small handful of trading wizards capable of the dynamic and stellar performance sought in the Hedge Fund structure.  All others are self-deluded, wannabe pretenders.  Show me five hedge fund "managers" and I will not likely be able to show you even one of those that is competent to hold your jock.  Show me ten hedge fund "managers" and I might be able to show you one of those that fits the bill, maybe.  Most of these guys absolutely suck penis at what they profess (to you) to do well.

Wed, 12/09/2015 - 18:56 | 6901546 nosam
nosam's picture

The only hedge fund managers that do well engage in insider trading or other illegal activities. Without insider trading, you are just as good as a monkey at a dart board.

Wed, 12/09/2015 - 20:36 | 6901985 SweetDougisaTwat
SweetDougisaTwat's picture

I'll entertain your point of view.  But, I need a concrete example of that.  Have one for me, please?  Anyone (a hedge fund manager) dutifully accused of or convicted of insider trading that you can identify?

Wed, 12/09/2015 - 16:46 | 6901004 scaleindependent
scaleindependent's picture

mother fuckers

Wed, 12/09/2015 - 19:10 | 6901057 Fuku Ben
Fuku Ben's picture

The fact that they are even using hedge funds is ridiculously risky and shows they are clearly chasing yield as is mentioned in the post. Many newer forms of pension plans were warned over the years and then finally sued for not allowing enough flexibility in choices of types of funds. That took many years to happen. Sorry you don't have years to wait this time.

Anyone that cares about their pension should take the stance that overtly risky or costly types of funds like hedge funds should not be a part of a pension plan. This is especially the case with those funds that have high fees and especially if it is an investment where you are forced to invest in a fund as a requirement of a pension plan. Or if any of the fees come from the plan as a whole where fees are shared by everyone and not completely from the individuals account that invests in the fund(s).

Legal consequences are typically what it takes for companies, and especially governments agencies, to act in your best interest. Read your pension contract or contact the appropriate licensed professional to figure out what is going on and what to do. Find out who has a fiduciary duty in the pension plan and what that entails. At a minimum someone should consider contacting the company, pension Administrator and Insurance company(s) that cover the fiduciary liability of those responsible for the plan.

Hedging your risk that your employer and pension Administrator are taking and placing on you means withdrawing your consent and placing the risk squarely back on them. How you choose to do that may determine later whether you have anything left in your pension. It also may determine whether you can recover what has been, is being, or will be stolen from your account through legal action against those responsible.

This doesn't even cover unfunded liabilities that have been stolen by not funding or are going to be stolen from you when they never fund it and declare bankruptcy.

Nothing I've posted should be misconstrued as financial or legal advice. Seek the appropriate professional assistance that meets your individual needs.

Wed, 12/09/2015 - 17:06 | 6901091 surf@jm
surf@jm's picture

Hey maybe all those pension funds should short the market, by buying SDOW, or something.....Of course, then Obama and the marxocrats would want to do like China. an arrest all short buyers.....But government pensions weighted so heavily into stocks, is one big reason the FED is desperate to keep the stock market bubble full of helium.....And this fact alone, plus Obama`s legacy not subjected to a financial crash, Hillary`s election not stymied by a financial crash, and governments of all stripes continiung to roll over and borrow more debt at ZIRP rates to keep the welfare state propped up should make people sceptical of the school marm (I like that term) at the FED of ever raising rates.....

Wed, 12/09/2015 - 17:22 | 6901174 Clesthenes
Clesthenes's picture

When these pension funds crash, “taxpayers and those who count on government services and investments will pay the price.”

These unrealistic assumptions aren’t the only snakes in their garden.

I recently examined retirement benefits paid by the Social Security, Public Employees (regarding states, counties, and cities) Retirement Systems (PERS) and federal retirement system.

With an identical earnings history for each category,

Social Security paid $1,527 per month.

California PERS paid $6,300.

Federal paid $5,600 to $6,200 – depending on variables.

It raises the question, “Is Social Security cheating taxpayers?

What a silly question.

Wed, 12/09/2015 - 18:29 | 6901252 SweetDougisaTwat
SweetDougisaTwat's picture

Interesting, Clesthenes.  Very interesting.  Might you entertain my stubborn need to see every pension as just a glorified annuity structure by reporting what typical principals the average recipients had paid in for them?  In Cali?  Federal?  Not the ROI, but the principal by perpetual contributions.

Say, in Cali, are we talking maybe $400K or $500K for those receiving $6300 each month?  More, I hope?

Wed, 12/09/2015 - 18:04 | 6901360 heresy101
heresy101's picture

Retirement funds should not be “investing”. The should be buying companies that are central to the economy and making them employee owned and operated. The trillions of dollars that retirement funds have could buy 51% of enough companies to make a substantial return (easily 7%) and get rid of the corporate parasites and their compensation tied to stock manipulation and the off-shoring of jobs! UPS, FEDEX, ATT, Verzion, the railroads (Buffett is going to kick off soon), electric utilities, major food producers (General Mills etc), GE, and many more that are key to the US economy would be on the list for purchase.

 

After capital investment, debt, etc, allocate the earnings 26% to retirement funds, 25% to employees, and 49% to external stockholder. This would be more return than comes from “investing” and much more than hedge funds provide. Allocate control on the Board of Directors as 51% to the retirement funds and workers and 49% control to outside investors. Employees have a huge incentive to run the company profitably and for the long run. It is very likely that employees and their local retirement funds would buy a good portion of the 49% stock. Multiple retirement funds should buy a company to spread the risk around.

 

Employees have an interest in the real productive economy and not the wall street casino. The workers, the retirement funds, and the economy would be much better off. Unfortunately, the corporate heads wouldn't be able to gamble with a companies future and would have to get a real job.

 

 

 

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