Russell Moore: Risk, Volatility + High Fees—Raimondo’s Gamble
Monday, May 13, 2013
A major hedge fund conference in Las Vegas reveals that RI Treasurer Gina Raimond's investment of pension funds may be a bigger gamble than previously thought.
GoLocalProv.com recently reported that under Raimondo's stewardship of the RI pension fund, fees paid to so-called "alternative investment" managers have swelled from just $13 million during the Frank Caprio era (among the lowest in the nation per capita), to roughly $50 million under Raimondo--a former alternative asset manager herself.
That fact has led Forbes Magazine's Ted Siedel to question whether pension reform in Rhode Island, passed in 2011 under Raimondo's behest, was nothing more than a "Wall St. Feeding Frenzy". And union leaders are now questioning why the state suspended cost-of-living adjustments for retirees, but see fit to pay 4.5 percent management fees to hedge fund managers.
GET THE LATEST BREAKING NEWS HERE -- SIGN UP FOR GOLOCAL FREE DAILY EBLASTGiven these facts, I decided to go right into the belly of the beast and get to the bottom of this.
I booked a flight and went directly to Las Vegas last week for the nation's pre-eminent hedge fund conference--the SALT conference, an acronym for the Wall Street gathering hosted by Skybridge Alternative Investments. I knew there would be well in excess of 1,000 investment managers there and if I wanted to learn more about the world of alternative investments, I figured I'd go directly to the source. (For the record, I don't think my motivation was dampened by the words "Las Vegas".)
Skybridge Alternative Investments is headed by the highly charismatic and affable Anthony Scaramucci, a former banker at Goldman Sachs and bestselling author who has made cameos in movies like Wall St 2: Money Never Sleeps. Scaramucci organizes the conference and markets it as a discussion and debate on global macro-economic trends, national and international political discussions, and cutting-edge scientific research and technology--all geared around how those developments affect the investment management community.
As is his custom, Scaramucci put together a stellar list of speakers including legendary actor Al Pacino, Duke men's basketball coach and two-time Olympic gold medal winning basketball coach Mike Krzyzewski, former French President Nicholas Sarkozy, former U.S. Senator Scott Brown, former U.S. Defense Secretary Leon Panetta, and scores of other highly accomplished speakers.
While seeing A-list celebrities and national politicians is all well and good, what really interested me was hearing some straight talk from the consultants and even some managers about the "alternative investment" industry's fees, volatility, and risk. To put it plainly, with respect to the idea of our state pension fund investing heavily in hedge funds: the more I heard, the less I liked.
What’s up with these fees?
For instance, they explained to me that the management fee structures for hedge funds were created and implemented back in the eighties, when it was typical for hedge funds to produce double digit returns on their investments.
Typically, a hedge fund manager will charge an "accredited customer" (rich guy or big institution) an up-front fee for the privilege of allowing them to manage their fund.
But wait, there's more!
Then, if the investor is lucky enough to see any profits, the hedge fund manager will then take roughly 20 percent of them. And if the hedge fund loses money, you might ask, does the manager share in the downside? Of course not!
All of this means that Rhode Island's so-called $50 million paid to hedge fund managers for fees are, in all likelihood, a low estimate. If Rhode Island sees profits on these investments, and we all hope we do for the sake of retirees and taxpayers, we'll be expected to share some of the profits, 20-percent perhaps, with the fund managers. That means we could be paying $80 million in fees to fund managers. Good work if you can get it.
I'm pretty sure Governor Lincoln Chafee has not yet trademarked horse racing analogies, so allow me to make one.
Imagine if a person approached a gambler at the horse track and offered to share his picks with said person. But there's a catch. The touter requires that his client to give him an upfront fee, plus a 20-percent share in profits. As someone who has been known to frequent Saratoga Springs on a yearly basis, I can tell you with the utmost confidence that just about any horse player will tell this touter in question that he can keep his picks to himself.
The major problem here is that the common misconception of the hedge fund industry is, thanks largely to media sensationalism, that because some funds have been able to garner big time returns, that's the norm for hedge funds.
It's like thinking every basketball player is Lebron James.
Raimondo has bought into the spin
Here's all you need to know about their actual performance.
At the close of the last calendar year, the S&P 500 index, a stock market index based on the market capitalization of 500 leading companies publicly traded in the U.S. stock market, as determined by Standard & Poor's, had outperformed hedge funds for 10 straight years according to a report in The Economist. So an investor who paid far lower fees and bought equities from the major US companies would have made far more money than the supposedly sophisticated "accredited" investor.
These days, hedge fund managers are going around selling their clients on the notion that hedge funds tend to be far less volatile investments than the S&P 500, and that's why investors aren't seeing the same forward momentum as the less sophisticated equities investor. I heard that plenty of times during the conference.
And that's precisely what Raimondo told WPRI reporter Ted Nesi when he asked her why the state has moved into hedge funds in such a big way (20-percent of the portfolio invested in the "alternative investments") during an interview a few weeks ago.
It's an interesting answer. At first blush, one would say it doesn't make sense, because the Harvard Endowment Fund and Yale Endowment Fund, two investment portfolios that rely heavily on alternative investments, have both lost much more money than Rhode Island did during the subprime mortgage crisis in 2008--despite Raimondo's argument that investing in alternative assets will prevent against a downswing such as that one.
(I can only imagine what shape the fund would be in if former treasurer Caprio had given in to hedge fund mania the way Raimondo and so many others across the country have.)
But even if Raimondo's premise was true, and it's not, it still wouldn't apply to the Rhode Island pension fund, which should be long-term oriented.
In other words, her answer doesn't make sense at second blush either.
It's not like the Rhode Island pension fund is some individual who is less than 10 years from his target retirement age, and has already "made his bones," to quote Moe Greene from The Godfather.
Public pension funds should be invested for the long haul. A public pension fund, such as the Employee Retirement System of Rhode Island, can take the long view, say, a 40-50 year view, than someone hoping to retire in 10 years. A dismal year here or there can be smoothed out over decades.
But Raimondo knows this already
It's very interesting to note that just a few months earlier in December of last year, that's exactly what Raimondo was saying. Asked by WRNI's Ian Donnis why the fund grew by just 1.4 percent over the previous fiscal year, this is how she responded.
"It’s important to realize that investments for pension funds and assumptions for investments for pension funds need to be looked at over the long term. There’s a great deal of volatility. So, for example, if you had picked the one year period from the beginning of October 2011 to the beginning of October 2012 it would have been 8.5 percent. So it’s actually quite dangerous to look at anyone 12-month period, because as you know, there’s a lot of up and down in the market.”
If it is "quite dangerous" to look any particular 12-month period, that prompts the question as to why Raimondo continues to cite the volatility in the market that took place in 2008 in the fallout of the subprime mortgage crisis, when she knows full well that the market has completely recovered and posted huge gains that exceed the highs of the 2007 bull market.
All of this makes one wonder what's the sense in paying hedge fund managers these extremely high fees at the expense of Rhode Island pensioners, state employees, and taxpayers.
Neither Raimondo, despite her Ivy League education and Rhode Scholar credentials, nor her former colleagues at the SALT conference, despite their lavish parties, great food, and A-list celebrity connections, have been able to explain this to me.
Pardon me if I don't hold my breath while waiting.
A native Rhode Islander, Russell J. Moore is a graduate of Providence College and St. Raphael Academy. He worked as a news reporter for 7 years (2004-2010), 5 of which with The Warwick Beacon, focusing on government. He continues to keep a close eye on the inner workings of Rhode Islands state and local governments.
