Poli-ticks

Our love affair with hedge funds is finally coming to an end

By Arlene Violet
Posted 10/5/16

Kudos to General Treasurer Seth Magaziner for finally seeing the light and cutting more than half of the state pension’s investment in hedge funds. I have written several columns, including …

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Poli-ticks

Our love affair with hedge funds is finally coming to an end

Posted

Kudos to General Treasurer Seth Magaziner for finally seeing the light and cutting more than half of the state pension’s investment in hedge funds. I have written several columns, including last month, about the gossamer wings supporting the pension fund returns and the too-high rate of return used by the system. Finally, the over-reliance on hedge funds (some 15 percent of the total portfolio) seems to be coming to an end.

Others, of course, like critic Ted Siedle and Michael G. Riley, have made cogent arguments to jettison the over-reliance on hedge funds. On September 29, Mr. Siedle reminded folks in GoLocalProv that Warren Buffett, arguably one of the genius investors of our time, warned 4 years ago that public pensions should avoid hedge funds and stick with a low-cost fund like the S&P 500 index. The fund Buffett picked for his holdings was up 65.67 percent vs. the high-cost high–risk hedge funds which averaged a return of under 22 percent for the same time period.

While then-treasurer Gina Raimondo should be credited with her leadership to reform the pension fund, there is no escaping her over-reliance on hedge funds for such a long duration. One of those funds which received the most in fees during her tenure is now poised to plead guilty to charges brought by the Security and Exchange Commission (SEC) involving massive graft, shell companies, and oil and diamonds rip-off. The firm, Och-Ziff, will probably pay in the vicinity of a $400 million fine. (GoLocalProv, 9/29/16) It’s discouraging to know that Rhode Island‘s pension system gave them millions of dollars in hedge fund fees which the company now will use to pay the fine.

Mr. Magaziner did not disclose which companies would “go packing” but did say it would take 2 years. While that may be a prudent move to stagger the withdrawal, it obscures the issue as to whether the reason for the timeline is because Rhode Island wrapped itself up in an unbreakable agreement with penalties for an earlier exit.

This, of course, brings up the entire issue of the alleged “secret proprietary data” drumbeat which precludes the public from knowing the terms of the deal with these hedge funds. It’s a pail of hogwash. Mr. Magaziner needs to end the secrecy since he will continue to have about 6.5 percent of pension funds in hedge funds after the purge. Claiming that he and before him, Ms. Raimondo, could not disclose the terms of agreement, certainly insulates them from any review as to the stupidity of the terms agreed to by them and the State Investment Commission.

Meanwhile, the other matter which the General Treasurer is “leaning towards supporting” is changing the assumed rate of return per annum of 7.5 percent for the pension fund. A few weeks ago I called for exactly that recalculation. The American Academy of Actuaries report referenced in the "Economist" (August 13, 2016 p. 55) excoriated the traditional valuation approach used by public entities and the 7.5 percent assumption as way too high. Continuing its use will lead to an extreme shortfall to pay future retirees and sticker shock to taxpayers.

While Treasurer Magaziner is to be commended for this first step, it’s time to take step Number 2 and use an appropriate projected rate of return.

Arlene Violet is an attorney and former Rhode Island Attorney General.

Arlene Violet

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