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Public Pensions, Hit by Low Returns, Cozy up to Wall Street

A combination of low interest rates and aggressive market return goals is driving pension funds toward more complicated, more dangerous and high-fee investments. Wall Street is happy to help out.

The FT has the story:

Mr Ablin has steered clients towards real estate investment trusts, preferred stock and master limited partnerships for infrastructure and pipelines, while also advocating high dividend-yielding stocks in the telecoms and utilities sectors…

Yet chasing income raises the risk that investors are piling into crowded trades that may reverse with a change in sentiment. Even if not, it may simply serve to pull down yields elsewhere…

André Perold, chief investment officer for HighVista Strategies, a hedge fund, and former professor of banking and finance at Harvard, says that in this environment the only way to hit return targets is through greater risk taking, through for example higher allocations to equities and equity-like asset classes.

For most institutions, however, he says that such an approach is a “loser’s game”. Calpers is a case in point. The pension fund has $5.1bn invested in hedge funds, but the five-year annual return from its Absolute Return Strategy is 0.7 per cent – better than its overall portfolio, but far worse than that claimed for the average hedge fund and nowhere near its long-term return requirement.

These risky investments can raise returns, but they can also lower them. The one and only thing they are guaranteed to produce is fat fees for Wall Street investment banks and hedge fund managers.

Via Meadia suggestions for public pension funds: Promise only what you can deliver, save aggressively, invest conservatively. It isn’t that hard, but you have to be honest and prudent to make it work. Politicians and union leaders who promise what they can’t deliver, not surprisingly, won’t deliver what they promise — except perhaps to the Wall Street fat cats who are the true beneficiaries of the current system.

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  • Anthony

    “…says that in this environment the only way to hit return targets is through greater risk taking….” Now, are public pension fund trustees and managers conversant with the probable risk/reward ratios and their future effect on asset streams?

  • thibaud

    “…perhaps to the Wall Street fat cats who are the true beneficiaries of the current system.”

    More progress. Nice to see VM’s author show some understanding of how the game’s played.

    What would also be nice would be some recognition of the way the fees and payout structure is rigged for the benefit of the Mitt Romneys of the financial world, at the expense of the public pension funds who make up the PE/hedgefunder crowd’s main investor class.

    Simon Lack, a 23-year fund-of-funds veteran of JP Morgan, has estimated that 84% of the returns over time flow to Romney and his ilk, leaving only 16% for the pension fund and other investors.

    If this ratio were reversed, public pension funds’ returns overall would have been increased by a non-trivial margin.

    Romney’s absurd campaign, with his stubborn insistence on not disclosing his tax returns as a way of deflecting attention from his financial engineering escapades, is providing a huge service to the public by putting a spotlight on a sleazy industry that works against the public interest.

    By November, the voters will have received an education in the fine art of “heads-I-win, tails-you-the-public-lose” financial engineering. They will not be happy with what they learn.

    As Mead likes to say, Change will come.

  • thibaud

    The problem goes beyond the “alternative” investment class. The public pension funds are victims of the private equity and hedgefund industry’s lopsided payout structure that ensures that the vast majority of the returns flow not to the investors in the fund but to the PE/hedgefund managers.

    Here’s Simon Lack, a 23-year veteran of JP Morgan’s funds of funds business, describing how it works. He estimates that an extraordinary 84% of all returns flow to the fund managers, leaving only crumbs for the public pension fund and other institutional investors.

    Were that ratio reversed, our public pension funds’ returns overall would be significantly higher, by maybe 100 basis points or more.

    In effect, the system is redirecting tens of billions of dollars every year from pensioners to the pockets of Mitt Romney and his ilk.

    One of the great benefits of Romney’s disastrous candidacy is the educational value it will provide to a public that, until now, has been largely ignorant of how the financial engineering industry picks their pockets.

  • Luke Lea

    Cozy up to Wall St? There goes the rest of the money!

  • Luke Lea

    So union pension funds are entrusted either to the mob or to Wall St. Is there a difference anymore?

  • M. Simon

    The same folks who need the returns for their future impede business at every opportunity. It will not end well. And since government pensions are fixed return rather than fixed investment the only way to cover the shortfall is to reduce services. Can cannibalism be far behind? I expect eat the old will be the new model. Or maybe “the city of ___ will be opening a new fertilizer plant to meet the pension shortfall.” A plan pioneered in Europe I’m told.

  • Jim.

    It’s worse than that — government policies are making it very, very difficult to gain 8% returns on ANY investment.

    Look at money as a commodity like any other. The price of money is its interest rate.

    Ben Bernanke’s “Free money” movement is a direct competitor for all the small-time savers (equivalent to small-time investors) that banks use to build up their cash-on-hand. Why should a bank pay good interest rates to a retail investor, with his heavy transaction costs, if by the stroke of a key (and some stroking of government types) they can get money for practically nothing?

    This has knock-on effects. Armed with Bernanke’s free money, they are able to offer money to other companies who want investment money on VERY good terms.

    How can a pension fund demand 8% or more from a company, when that company can go to a bank and get that money at half the cost, or lower?

    Basically, by reducing the prime rate to nothing, Bernanke has flooded the market with cheap money like China floods the market with cheap goods, or like Latin America floods the US with cheap labor. People with savings accounts, and yes, pension funds, find that their money simply isn’t in demand.

    Bernanke should stick to buying up US Treasuries… at least that helps us battle our debt.

    The second obstacle that Government puts in the way of achieving the sort of broad-based 8% growth that massive pension plans require, is by strangling business in red tape. Sometimes they outsource these sorts of executions to private enterprise, in the form of requiring ISO certification (i.e., document EVERYTHING, and spend more time teaching employees to fill out forms than to do their actual jobs) to compete on government contracts.

    – Cut regulation.
    – Cut red tape.
    – Reduce the reliance on ISO in government contracts; rely more on company past performance
    – Raise the prime rate
    – If you need to pump money into the economy, pay off national debt by buying up Treasuries and forgiving them.

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