– New Jersey’s Debt is Downgraded by Fitch as Chris Christie Funnels Pension Money to Private Equity and Hedge Funds (Liberty Blitzkrieg, Sep 8, 2014):
David Sirota must be commended for his incredible work this year exposing the insidious relationship between public pension funds and “alternative asset managers,” namely private equity firms and hedge funds. It is the private equity component that has captured my attention the most due to the industry’s notoriously opaque and seemingly illegal fees.
One example I highlighted earlier this year was: Leaked Documents Show How Blackstone Fleeces Taxpayers via Public Pension Funds. The reason this relationship between public pension money and private equity is so incredibly important is because so many in the private equity world are so incredibly shady. Let’s not forget what SEC official Drew Bowden said back in May:
At a private equity conference this week, Drew Bowden, a senior SEC official, told private equity fund managers and their investors in considerable detail about how the agency had found widespread stealing and other serious infractions in its audits of private equity firms.
Despite the at times disconcertingly polite tone, the SEC has now announced that more than 50 percent of private equity firms it has audited have engaged in serious infractions of securities laws. These abuses were detected thanks to to Dodd Frank. Private equity general partners had been unregulated until early 2012, when they were required to SEC regulation as investment advisers.
So how do public pensions fit in to this racket? Here’s how:
Bowden heads the SEC’s examinations unit, and his rap sheet was based on his two years of experience in auditing private equity firms. As bad as embezzlement and other sharp practices are, at least as troubling is the revelation that the limited partners have been derelict in their duties. They’ve agreed to terms in their relationship with the general partners to make it easy for the general partners to abuse the investors. The general partners can steal from their limited partners because the limited partners are asleep. The LPs have failed to negotiate for contractual protections when they have the most leverage, prior to investing, and they’ve been unwilling or unable to monitor their investments effectively once they’ve handed over their money.
As is made clear above, private equity firms need the perfect sucker. Huge pools of money run by compromised money managers. It appears public pension funds across America have been tripping over each other to pay enormous fees to alternative asset managers for the privilege of underperforming simple index funds.
In this hierarchy, there are few states as corrupt as New Jersey, thanks in large part to the man running the state, Governor Chris Christie. Before reading the current article I suggest getting caught up on the issue by reading the following Sirota articles:
Now here are some excerpts from his latest piece:
Since Gov. Chris Christie took office, he has nearly tripled the amount of retiree cash invested in alternative investment firms — many of whose employees have made financial contributions to political groups backing Christie’s election campaigns. In that time, the gap between New Jersey’s alternative portfolio and the broader market has rapidly expanded, costing taxpayers billions in unrealized returns and threatening the financial stability of the $78 billion pension system. The state’s pension funding shortfalls — which have been exacerbated by Christie’s market-trailing investment strategy — were one of the factors cited by Fitch Ratings in its decision last week to downgrade the state’s bond rating for the second time.
“The idea that hedge funds, private equity funds and other alternative investments beat stock-index funds over the long haul is an urban myth like the tooth fairy,” said Jeff Hooke, a former Lehman Brothers investment banker who in 2012 published a study showing that higher alternative investment fees correlated to lower pension returns. “The managers of these big state pension funds are drinking the Wall Street Kool-Aid. The problem with these alternative investments is that they have a tough time beating the low-fee index funds because the fees for alternatives are so big.”
Private equity executive Robert Grady, the Christie-appointed chairman of the New Jersey State Investment Council who championed alternative investments, did not respond to IBTimes’ request for comment, nor did Christie. However, the governor responded last month to criticism of his administration’s investment strategy by pointing out that the pension has “overperformed” his own officials’ projections.
No worries, when pensioners fail to get paid, you can just tell them they still hit the “Christie target.”
Yet, as IBTimes reported last week, the New Jersey pension fund’s overall returns have trailed median public-pension returns. And while Grady had promised to begin “lowering the burden of fees” on pensioners, state documents show those fees have tripled since Christie took office, costing state taxpayers almost $1 billion — or roughly $300 for every household in the state.
Applying those returns to New Jersey’s alternative investment holdings, pension consultant Chris Tobe estimates that New Jersey taxpayers lost more than $5.8 billion in unrealized returns since Christie took office. Put another way, Tobe’s calculations show that had Christie officials followed the path of Buffett and other pension funds that invested cash in low-fee stock index funds rather than with high-fee Wall Street money managers, New Jersey would have almost 7 percent more in its pension system than it does today. That $5.8 billion would be more than enough to fulfill the pension payments Christie recently opted to cut.
“Alternative investments were sold to many pension trustees as delivering as good or better returns than the S&P, but as New Jersey and other states show, that has proven to be false,” said Tobe, author of the book “Kentucky Fried Pensions” and a former public-pension trustee. “While this has been a good stock market, it will be almost impossible for alternatives to catch up in the foreseeable future given the drag on their returns due to the high fees.”
In response to questions about the pension fund’s performance, Santarelli downplayed New Jersey’s exposure to alternatives, insisting that as of May, alternatives accounted for only 26 percent of the Garden State’s pension fund. State documents show New Jersey has authorized a total of $29 billion to be committed to alternatives — or roughly 37 percent of its entire pension fund. Grady in 2011 championed a plan to allow Christie officials to invest up to 38 percent of the fund in alternatives. A recent report by Pensions and Investments found that New Jersey is the second-largest public pension investor in hedge funds.
Grady has asserted that one benefit of the alternative investments is that “you dampen the effect of a big drop” in the stock market. That proved true in 2008 — the one year out of eight that New Jersey’s alternative portfolio outperformed the S&P 500. But the principle did not hold up since then, as the state’s alternative investment portfolio trailed the S&P in weak stock market years such as 2009 and 2012. And the one year in which the alternatives outperformed the S&P was not enough to wipe away losses from unrealized gains in all the other years.
“Over long periods of time, whatever minimal protection against drops you might get from alternative investments is sacrificed by underperforming for the other eight or nine years,” said Hooke, who is now vice president of the business-led Committee for Economic Development. “If you are worried about one down year, then rather than buy expensive alternatives, you can just buy cheaper forms of portfolio insurance to protect against a huge market drop. That would save billions of dollars.”
As I have said before, I predict this relationship between public pensions and private equity will be at the very center of the next big financial crisis.