RI Pension Fund Lost out on $700M in Potential Revenue
Thursday, July 25, 2013
The state pension fund had a return of about 11 percent for the last fiscal year—a ten-point lag behind the performance of the stock market that has cost the retirement system hundreds of millions in potential revenues, according to new data released yesterday.
The returns for fiscal year 2013 brought $801 million in revenue. But had the fund mirrored the stock market, it could have almost doubled that amount.
For example, the Russell 3000—a leading index of the stock market used by the state pension fund—was up by over 21 percent last year. Had the state pension fund, which began the year with $7.2 billion in assets, matched the Russell 3000, it would have earned an estimated $751.8 million more in revenues.
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Of course, the performance of the state pension fund historically has not replicated that of the stock market. But it’s come close.
The returns for the state pension fund were nearly 86 percent of the Russell 3000 index in 2010 and nearly 63 percent in 2009. Had the pension fund mirrored the stock market last year the way it did in 2010, it would have earned $530.2 million more. Had it resembled 2009 it would have earned $176.7 million more—almost exactly what the state had been paying out in cost of living adjustments before COLAs were suspended as part of pension reform.
Since taking office, General Treasurer Gina Raimondo has changed the state’s investments so that they are not as closely tied to the stock market. In the first year into that shift, the pension fund had a return of 1.55 percent, far below the Russell 3000 return of 9.3 percent. Last year’s return of 11.07 percent is better, but still barely half the Russell 3000 index of 21.56 percent.
Ted Siedle, a Forbes.com contributor who has sharply criticized Raimondo’s hedge-fund strategy, said the performance over the past year has not been good. “Clearly it reflects how high-cost, high-risk investments undermine the investment performance,” said Siedle, who has been hired by AFSCME Council 94 to do a forensic investigation into the state pension fund.
Raimondo defended her approach yesterday. “The job of the pension fund isn’t to mirror the stock market. The job of the pension fund is to be diversified so that we can provide strong long-term returns at the appropriate level of risk, so we can pay pension checks and people have peace of mind and retirement security,” Raimondo told GoLocalProv. She she was pleased with the returns, which she saw as validation of her investment strategy.
That strategy comes at a cost. “In the urgency to not experience deep losses what you do is you have the loss of gains,” said Marcia Reback, a member of the state investment commission and former head of the Rhode Island Federation of Teachers and Health Professionals.
But the rollercoaster ride of stock market returns is exactly what Raimondo wants to avoid. In 2011, a steep climb in the market produced roughly one billion in earnings for Rhode Island, but that was after the pension system lost nearly $2 billion in a single year during the market nosedive.
“That is an unsustainable level of risk,” Raimondo said. “We know that the changes we’ve made have in fact reduced that risk.”
The problem with taking hits in the market is compounded by how much the fund has to pay in pension checks, according to J. Michael Costello, a member of the state investment commission and president of Endurance Wealth Management. Last year, the fund paid out about $924.1 million in benefits to retirees, according to state data released yesterday.
Many institutional investors have turned to hedge funds, private equity, and other alternative investments in the wake of the market crash, Costello said.
At one time, state pension funds might have about 60 percent of its assets in equity and 40 percent in bonds to protect them against market downturns, Raimondo said. “Unfortunately we’re looking at a scenario where bonds aren’t really paying anything so we have to be a little bit more creative and innovative to look for other ways to protect us on the downside and that’s why some of these alternative investments [are] the right thing to do,” she said.
Ocean State invests more than others in hedge funds
Rhode Island leads its peers in terms of hedge fund investments: as of June 30, 2012, the state had 13.9 percent of its money in hedge funds, ten times above the median for state pension funds, according to data cited in a WPRI.com report. (That figure does not include the total amount of alternative investments, which is closer to 25 percent.)
But Rhode Island could be lagging when it comes to returns.
In a review of seven randomly selected pension funds, all were ahead. The California Public Employees Retirement System had a return of 12.5 percent last year. Massachusetts was slightly above, at 12.7 percent. Out of the seven funds, the highest return—16.3 percent nine months into the year—went to the Oklahoma Teachers Retirement System, which started out the year with no money invested in alternatives, according to Pensions & Investments, an industry publication.
“I think we’re over-weighted in ‘low-risk’ investments,” Reback said.
Costello, on the other hand, said a return of 11 percent with lower risk was good.
He said it’s “naïve” to assume returns should mirror the stock market: hedge funds and other alternatives, he said, are not designed to outperform the market. Instead, he said such funds are designed to shield investors from the down years in the market.
Do hedge funds shield investors from market crashes?
But that theory has been challenged, most recently in a Bloomberg Businessweek critique, which cited data from Hedge Fund Research showing that the hedge fund industry was outperformed by the S&P 500, another stock market index, in 2009. In 2008, the hedge fund industry overall had a negative return, though not as severe as the S&P 500.
During the market crash, alternative investments were blamed for causing some of the biggest losses for two prominent investors: the endowments for Harvard and Yale. “Harvard’s endowment tumbled 27.3 percent in its latest fiscal year, largely because of problems with its private equity and hedge fund portfolios, lopping off $10 billion and shrinking its portfolio to $26 billion. Taking into consideration donations and spending, the endowment shrank by nearly 30 percent,” the New York Times reported in September 2009.
The same report noted the declines in its publicly traded investments for Yale stopped in January 2009 while its alternative investments in private equity and real estate continued to lose value throughout the rest of the fiscal year.
Hedge fund fees not disclosed
Hedge funds have become controversial not only because of how their returns compare with the stock market, but also because investors pay more in fees to the managers of those funds than the fees for funds indexed to perform with the stock market. Typically, a hedge fund will have 2 percent annual management fees, coupled with 20 percent performance fees on any gains.
Those fees, critics say, cut into the already low returns hedge funds generate.
Yesterday, the treasurer’s office declined to release the total amount it had paid out in hedge fund fees for the fiscal year, even as it released reams of other data about how the fund’s investments had performed, which state officials said took into account the cost of the fees.
“We don’t have the comprehensive numbers yet, just because it takes a little while to get everything together and … finalized,” said Anne-Marie Fink, the chief state investment officer, when questioned by Reback about the fees at yesterday’s monthly meeting of the state investment commission.
Fink said she would try to have the data on fees compiled by the next meeting, which is scheduled for September.
“I think they have them,” Reback told GoLocalProv. “They’re just not showing them.”
Stephen Beale can be reached at [email protected]. Follow him on Twitter @bealenews
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