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EXCLUSIVE: State Pension Fund Lost $200M under Raimondo

Thursday, April 25, 2013


The state pension fund lost more than $200 million in fiscal year 2012 as the state moved into hedge funds and other alternative investments under General Treasurer Gina Raimondo, raising questions about the investment strategy she has pursued and the viability of the pension reforms she has orchestrated.

The assets in the state pension fund dropped from $7.488 billion in June 2011 to $7.284 billion a year later, a decrease of $204 million, according to the independent annual audit. Overall, the fund had a positive rate of return of 1.55 percent during the same period. But the fund still lost money because the benefits paid out wiped out the modest gains for the year and exceeded the amount of new contributions to the fund from workers and the state.

It was the first time the fund suffered a net loss since the recession. The accompanying rate of return was the lowest for a non-recession year in a decade. (See below table.)

Before Raimondo took office, the state pension fund was on track to recover the $2.5 billion it had lost in the recession.

In fiscal year 2010, the fund gained $508 million with a return rate of 13.46 percent. In 2011, assets increased by $911 million, fueled by a return rate of 20.4 percent, with the bulk of the growth occurring in the first six months of that fiscal year, before Raimondo took office in January 2011.

The lower returns coincide with higher fees the state is paying to investment managers.

During the Caprio era, the investment fees were among the lowest of any state pension fund in the country, with .215 percent of net pension assets going towards fees for investment managers in fiscal year 2010. Under Raimondo, the cost of investment fees has nearly tripled to .58 percent of pension assets, according to documents her office provided to GoLocalProv yesterday.

Missed opportunity to recover recent losses

A state labor leader called the pension fund losses ‘outrageous’ given the continued recovery of the markets in 2012. “You would expect that the people investing our pension money would have capitalized on that,” said Frank Flynn, the president of the Rhode Island Federation of Teachers and Health Professionals.

“It kind of makes you wonder about the management of the fund,” he added.

In the first six months of Raimondo’s tenure, the state’s pension investments remained largely unchanged from her predecessor. But in June 2011, the State Investment Commission, which Raimondo chairs, approved a plan that made significant changes to where the state allocated its assets.

One year later, a quarter of state pension assets were in alternative investments, including $1 billion in hedge funds, state records show. Raimondo has said one of her chief aims in the new investment strategy is to reduce risk.

But one member of the State Investment Commission, Marcia Reback, worries that the strategy is so risk-averse that the state is not making the 7.5 percent assumed rate of return—one of the key assumptions on which pension reform was predicated. She said the state has to balance out its investment portfolio so that it can capitalize on the post-recession uptick in the markets.

“What we’re doing is being so [risk-averse] in our investments, we’re not capturing the up-market,” said Reback, the former president of the Rhode Island Federation of Teachers and Health Professionals.

Is Raimondo right about hedge funds?

Others are questioning whether investing in hedge funds even reduces risk, as Raimondo claims. One critic who has emerged recently is Forbes.com columnist Edward Siedle, who has launched a blistering broadside against Raimondo’s pension reform. Siedle has specifically taken her to task for moving pension assets into hedge funds, which he says are “high” not “low” risk. He has described her approach as using "unsustainable investments" to solve "unsustainable pensions."

Siedle’s position appears to be in line with one of his former employers, the U.S. Securities and Exchange Commission, which has noted that many hedge funds use “leverage … short-selling and other speculative investment practices that are not often used by mutual funds.” The SEC’s Office of Investor Education and Advocacy describes leverage as “borrowing to increase investment exposure as well as risk.”

“The thing about hedge funds is that they make a ton of money—for the people who own them. For their customers, not so much,” said Tom Sgouros, a progressive blogger and past candidate for state treasurer. “Their fees are quite high, and so is the risk, which is funny, since the point of hedging is supposed to be reducing risk. This is not to say there are no lucky customers, but the odds are clearly on the side of those who think our investments in hedge funds are not going to perform well.”

How other states compare

Raimondo spokeswoman Joy Fox noted that the state’s performance in 2012 was “comparable to other public pension plans similar to Rhode Island.”

A cursory review of other similar-sized states shows Rhode Island behind some peers and ahead of others in fiscal year 2012. Vermont had a rate of return of 2.2 percent or higher for the three pension plans it has. Delaware had a 2 percent rate. Two other New England states did worse than Rhode Island: New Hampshire and Maine were both between one percent and half a percent. (See table.)

But, like Rhode Island, at least three of those four other states saw dramatic reductions from rates of return that were in double digits in the previous fiscal year.

When asked to explain why the pension fund lost money in 2012, Fox said the benefits paid out to retirees exceeded the total contributions from workers and the state itself by approximately $400 million. The financial audit for the year shows that $881.1 million was paid out in benefits against $582.7 million in new contributions—a difference that could not be made up by $115.6 million in investment returns for the year.

Impact on pension reform

“Passing the Rhode Island Retirement Security Act of 2011 has put the pension on a path to fix this situation over the long term,” Fox said.

But some worry that the low rate of return undermines the just-passed pension reform, which included as one of its key assumptions an assumed rate of return of 7.5 percent. “The numbers obviously have been overestimated,” said state Rep. Karen MacBeth, D-Cumberland. “When we passed pension reform this was an expectation and we’re not meeting it with our rate of return.”

The rate of return for pensions is often viewed as a five-year average. As of 2012, that average was 1.19 percent, according to the annual audit. One year earlier, it was 4.02 percent.

“Any five-year average that includes 2008 and 2009 is going to be below the target,” Sgouros said. “It’s a shame we weren’t able to move the return back closer to the target range in a year that saw dramatic gains in the equities markets.”

The final returns for fiscal year 2013 are months away, but so far, in the fiscal year to-date the rate of return is about 11 percent, according to Fox. However, that still won’t be high enough to raise the five-year average to 7.5 percent.

MacBeth said the state can’t afford to wait too far into the future to address the low rate of return. “We’re not meeting our rate of return,” she said. “We need to figure that out now.”

She said state lawmakers owe it to the public who have entrusted them with reform, as well as the state retirees who have already taken a hit in their pension income.

The landmark pension reform legislation that passed in fall 2011 took effect in July 2012. Changes to benefits, including a suspension of cost of living adjustments, are expected to save about $4 billion over 20 years, according to Fox. That translates into an annual savings of $200 million.

Stephen Beale can be reached at [email protected]. Follow him on Twitter @bealenews

Excerpts from Comprehensive Annual Financial Report for Fiscal Year 2012


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