STUMP » Articles » Public Pensions Watch: More Reactions to Calpers Pulling Out of Hedge Funds » 18 September 2014, 01:30

Given Ted Siedle’s involvement in commenting about other pension funds being in hedge funds, I knew I had to only wait for his comment on Calpers pulling out of hedge funds:

Rolling the dice on hedge funds has proven disastrous for CalPERS and its stakeholders, including taxpayers. The annualized rate of return on its hedge fund investments over the last 10 years is reportedly a paltry 4.8 percent, about half the S&P 500’s return of 8.12 percent. That’s about $1.3 billion in underperformance.

High-risk, low return is generally considered the very definition of a doomed investment. Yet the interim chief investment officer of the fund is quoted as saying the decision to eliminate hedge funds isn’t related to the performance of the program. It seems the fees and the complexity—two massive drawbacks of hedge funds which have always been known to CalPERS—are the reason for ending the program twelve years too late. CalPERS had better come up with a more believable explanation. Global warming?

“Red flags” related to this costly roll-of-the-dice are copious. Californians would be well-advised to investigate the unprecedented emergence and elimination of this entire asset class at CalPERS, in my opinion. The wreckage was clearly foreseeable and, indeed, foreseen by experts not party to the hedge fund daisy chain. Placement agents, investment consultants, fund managers, lawyers and others who played a role, should be held accountable. It seems many of the culprits are involved in similar scheming at other public pensions.

Well, actually, the ex-CEO of Calpers pled guilty this past summer of all sorts of investment shenanigans:

The ex-CEO of CalPERS, Fred Buenrostro, has just pleaded guilty to accepting doucers, cash bribes and fees for placing investment business with a specific firm.

The specific guilty plea:

Buenrostro is the former Chief Executive Officer (CEO) of the California Public Employee Retirement System (CalPERS). In pleading guilty, Buenrostro admitted to conspiring with Alfred J. Villalobos, founder and operator of ARVCO Capital Research LLC (ARVCO). Buenrostro acknowledged in court today that he understood that Villalobos operated ARVCO as a placement agent that solicited investments by public pension funds into private equity funds. Buenrostro also admitted that he understood that ARVCO was typically paid an agreed-upon fee based on the percentage of the total dollar amount invested by the public pension fund.

As per yesterday’s post, remember that hedge funds are just a legal structure, and can be involved in private equity funds, too. Might be some interesting digging in the hedge fund relationship. There are very good reasons to be skeptical of how investments in these hedge funds were chosen.

Megan McArdle on the move by Calpers:

However, it’s worth noting what this means: California has given up on the hope of above-market returns from hedge fund investments. There is a reason that public-sector pensions have been pouring money into hedge funds: It’s become clear that they are dramatically underfunded. California, for example, is about 25 percent underfunded, according to its chief actuary, with only a 50 percent chance of meeting its 7.5 percent target for annual investment returns.

A state can deal with a pension shortfall in two ways: It can raise contributions, or it can try to get higher returns out of the assets it already has. As mentioned above, this isn’t really a strategy that’s open to a fund as large as Calpers, but that hasn’t stopped Calpers from trying. After a series of grossly irresponsible pension enhancements at the height of the stock market bubble, Calpers tried to make up for the shortfalls by using accounting gimmicks to lengthen the schedule of top-up contributions and pushing into riskier investments.

Now the riskier investments have failed, and the accounting gimmicks were mostly based on the hope that the higher returns would bail Calpers out at some unspecified later date. That leaves the California taxpayer with higher contributions. This has already become a problem with many state and local governments; expect it to become a problem for many more.

That doesn’t mean Calpers is doing the wrong thing by getting out of hedge funds; on the contrary, it’s recognizing the inevitable, and it’s always better to do that sooner rather than later. But it’s going to hurt.

This realization has already come to many other public pension plans, which have lowered their discount rates in recent years. But many others are still trying to chase returns, as my alternative assets in public pension fund series has shown.

Alternative Assets series:
1. Don’t go chasing waterfalls….or Alternative Asset Classes

New Jersey and NJ followup

South Carolina

San Diego

A break for some alternative asset boosterism

Rhode Island

North Carolina

California pension fund pulling out of hedge funds and Immediate reactions to this move