Alternative holdings sour for endowments, pensions

Date: Thursday, December 4, 2008
Author: Rachel Beck and Joe Bel Bruno, Associated Press

College endowments and state pension funds plowed billions of dollars into hedge funds and private-equity investments as a way to balance their stock holdings, and for a time they got supercharged returns.

Those days are over. From Harvard University to the state pension fund of California, officials are watching the value of their alternative investments shrink.

So far, the losses are mostly on paper, but analysts say they could eventually lead to reduced payouts to retirees, higher taxes so state governments can fulfill their promises, or less cash available for colleges to give out financial aid.

"Everyone was in a desperate search to find returns," said Colin Blaydon, head of the Center for Private Equity and Entrepreneurship at Dartmouth's Tuck School of Business. "Now they have to face the dirty little secret that those investments aren't in great shape."

In recent years, endowments and pensions heaped cash into hedge funds — private investment funds that often use unconventional and risky trading strategies. And they also bought into private equity funds, which make direct investments into private companies or buy them out.

It's too soon to know the depth of the damage from these investments. Annual results won't be in until January for pensions and July for endowments.

But there are already indications that the value of these alternative investments is falling, including disclosures from some publicly traded private-equity firms that some of their holdings are worth less than they were just months ago.

The weakness in those holdings has delivered another punch to colleges and pension funds, which are bracing for the worst.

_Harvard University announced this week that its endowment tumbled since July 1 by about $8 billion, or 22 percent, to about $29 billion, and said that "sobering figure" doesn't fully capture its losses because it doesn't reflect declines in its private-equity and real estate investments. It forecast total losses for its fiscal year ending in June 2009 could be as much as 30 percent, its worst performance on record.

"All of us will need not merely to contemplate changes at the margins, but to take a more fundamental look at how to align our spending with revenues that will be significantly reduced from what we had imagined just a few months ago," said a Dec. 2 letter from university leaders to deans.

_In California, the public pension fund Calpers says state, local and county governments may have to chip in as much as an additional 4 percent beginning in mid-2010 to cover its pension losses. Its total assets had fallen from $260 billion last fiscal year to just $178 billion on Dec. 1.

_The pension fund for public employees in Wisconsin says it may have to cut monthly payments to retirees by as much as 3.5 percent — the first reduction in its 26-year history. Its Core Fund, a mix of investments including private equity, lost 26 percent from January through October.

If that happens, Berland Meyer, a retired deputy school superintendent in Wausau, Wis., said he and his wife, a retired teacher, expect they could receive up to $1,000 less per month in state annuities.

"We won't go out to eat as much as we had in the past," he said. "I'm sure I won't be buying as many trinkets at Home Depot. ... We'll do a lot more thinking before we spend."

This was hardly what pension funds and endowments had in mind.

After the dot-com stock bust wrecked their portfolios at the start of the decade, pensions and endowments poured cash into hedge funds, private equity, commodities and real estate — and for a few years, it looked like a smart move.

For private-equity firms, the strategy was to purchase companies, strip out costs and flip them for a profit. Investor cash and massive debt fueled their buying sprees.

The Robert Wood Johnson Foundation, which has more than $10 billion in assets intended to support health care causes, boosted its alternative holdings from 13 percent of its total investments in 2001 to 33 percent in 2007, according to its financial reports. It has not disclosed any recent information about performance.

And last year, the nation's state and local pension funds put $147 billion into alternative investments, 18 percent more than the year before, according to research by the National Association of State Retirement Administrators.

Educational endowments put about $144 billion into alternative investments from July 2006 through June 2007, about 8 percent more than the year before, according to Commonfund, which advises and manages money for universities and nonprofits.

Critics say the party had to end.

Doug Kass, president of the Florida investment firm Seabreeze Partners Management, says hedge and private-equity funds overpaid for many takeovers, used too much debt to finance the deals and charged excessive fees. So when bad times come and the now-private companies struggle, those investors will be the first to lose if companies go bankrupt or need restructuring.

"These funds relied on the kindness of institutional investors who were intoxicated by hysterical returns," said Kass, who is known as a short-seller, or someone who makes bets on declines in the market.

Already, managers of hedge and private-equity funds are pressing investors to pony up more cash to avoid having to sell assets at fire-sale prices.

At the same time, some pension funds and endowments are looking to sell their alternative holdings — and get out before they're hurt even more.

Private-equity funds account for about $900 million of the University of Virginia's endowment and other funds, or about one-fifth of the total holdings. Those private-equity investments dropped nearly 13 percent from July to September.

The company that manages the holdings may sell some of the private-equity investments "at attractive prices," according to a recent letter from its CEO. But anyone who wants to sell now faces a weak market.

The state pension fund in New Jersey is actually buying — putting nearly $300 million into four hedge funds in October, at the height of the financial market meltdown.

Among the investments was an extra $144 million into a fund managed by BlackRock Inc. after the investment firm called for an emergency cash infusion. The addition brought New Jersey's stake in the fund to $544 million.

State officials said it was still a good investment, and they expect a return of 20 percent on the new contribution. But one lawmaker said it amounted to throwing good money after bad.

"Hedge funds are supposed to act as insurance against market volatility," said New Jersey state Sen. Joseph Pennacchio, a Republican. "Now we have to insure the insurance."

Associated Press writer Ryan J. Foley in Madison, Wis., contributed to this story.