Hedge Funds Lure More Cash From Pensions as Benefit Gap Looms

Date: Thursday, February 25, 2010
Author: Bloomberg

Feb. 25 (Bloomberg) -- Florida’s state pension system, manager of $112 billion for a million firefighters, teachers and garbage collectors, is set to decide next week on the size of its first investment in hedge funds.

Executives of the fourth-largest state retirement program in the U.S., who have considered putting money into the private pools of capital since 2007, will make the move amid a 7 percent shortfall in its ability to pay future benefits, the first in 13 years. Wisconsin’s pension also plans its initial allocation this year, while Boeing Co.’s probably will raise its holdings.

Public and private pensions are increasing hedge-fund commitments after slowing the flow of cash at the end of 2008. About 15 percent of U.S. institutions plan to boost their allocations, and 80 percent will keep them steady, according to a survey by SEI Investments Co. The investors are seeking to accelerate returns after losses during the financial crisis.

“In 2008, everyone stopped allocating,” said David McMillan, director of hedge funds at Hammond Associates Inc., a St. Louis, Missouri-based consultant that advises pension funds with $23 billion in assets. “I expect to see the pace of investing pick up.”

Pension managers with hedge-fund holdings oversee about $3.2 trillion, according to Casey, Quirk & Associates LLC, a consulting firm based in Darien, Connecticut. While no estimates are available for how much money these funds might allocate in 2010, a 1 percent increase would translate to about $32 billion in inflows for the $1.6 trillion industry.

Below Targets

Corporate pensions are about half a percentage point below their average hedge-fund target of 10.2 percent of assets, while public systems are 1.4 percentage points below their 7.8 percent goal, according to SEI, an Oaks, Pennsylvania-based investment manager and consultant. Both groups raised their targets in 2009, setting the stage for new investments this year.

U.S. states face a gap of more than $1 trillion between what they have saved and what they have promised to retired workers in pension and health-care benefits, according to a report released this month by the Pew Center on the States, a Washington-based research and advocacy group. The 100 largest corporate pension funds had a $324 billion shortfall as of January, according to a statement by Seattle-based consultant Milliman Inc.

Equities Not Enough

“Pension funds want to reduce the volatility of returns, and they don’t think equities will get them to their return targets,” said John Haugh, head of U.S. pensions and endowments research at Bank of America Merrill Lynch Global Research in New York.

U.S. stocks, as measured by the Russell 3000 Index, are about 20 percent below their level in 2000. With interest rates just above record lows, returns on government bonds, a staple of pension-fund holdings, have declined.

Public pensions rose an average of 3.7 percent annually in the past 10 years, while corporate plans gained 3.6 percent, Haugh said. Both have a target of 8 percent.

Haugh said pensions also will invest in commodities, real estate, Treasury Inflation Protected Securities and natural resources such as timberland to counter their expectations of rising inflation.

Hedge funds gained an average of 6.6 percent a year in the past decade through Jan. 31, according to the Credit Suisse Tremont Index. That compares with an average annual loss of about 1 percent by the Standard & Poor’s 500 Index and a 6.6 percent return by U.S. bonds, based on the Barclays Capital U.S. Aggregate Index.

Redemptions End

Investors pulled $298 billion out of hedge funds from Oct. 1, 2008, through June 30, 2009, according to Hedge Fund Research Inc. A net $15 billion flowed back in during the second half of last year, data from the Chicago-based research firm show. Funds attracted $140 million in inflows in January, Eurekahedge Pte, a Singapore-based research firm, said yesterday.

“The majority of dollars coming into hedge funds in the next 12 months will primarily come from pension plans,” said David Harmston, head of the client group at London-based Albourne Partners Ltd., which advises 36 pension plans with $40 billion invested in the funds.

The biggest funds, with extensive infrastructure and risk- management systems, are benefiting the most. Steven Cohen’s SAC Capital Advisors LP pulled in $1.3 billion between June and December, and Tudor Investment Corp.’s BVI Global Fund Ltd. raised the same amount between March and July before closing to new cash. SAC is based in Stamford, Connecticut, while Tudor is run by Paul Tudor Jones in Greenwich, Connecticut.

Florida, Wisconsin

Pension funds and endowments invested $7.67 billion in hedge funds last year, a decline of 47 percent from 2007, according to Eager, Davis & Holmes LLC, a consultant based in Louisville, Kentucky, that tracks money-management hiring.

In Florida, the retirement system designated $1.75 billion during the year ending in June for assets that include timberland and infrastructure, Dennis MacKee, a spokesman for the State Board of Administration in Tallahassee, said in a telephone interview. Its investment advisory council will discuss how much of that money to steer into hedge funds when it meets March 3.

Wisconsin Retirement System, which oversees $72 billion and was 88 percent funded at the end of 2009, is planning to invest in hedge funds for the first time this year, according to Vicky Hearing, a spokeswoman for the Madison, Wisconsin-based plan.

“We are looking to diversify to reduce volatility in our overall portfolio,” she said in a telephone interview. The pension fund plans to initially invest in 15 managers and increase that number to 25, according to a December report.

More Direct Investments

In 2009, about 80 percent of the money invested in hedge funds went through middlemen known as funds of funds, according to Eager Davis. Some pensions are looking to deal directly with fund managers.

Boeing, the second-largest U.S. defense contractor, expects to add about $400 million this year to the $1.3 billion it has with hedge funds, according to Todd Blecher, a spokesman for the Chicago-based company. Hedge-fund holdings of the plan, which oversees $46 billion, are done through middlemen, though the company may begin making direct investments, he said.

Universities Superannuation Scheme, which oversees 30 billion pounds ($46 billion) for U.K. university employees, is one of the pension managers that first invested directly when it started allocating to hedge funds last year.

“We want to have control, transparency and responsibility over picking managers,” Mike Powell, who oversees the organization’s alternative assets out of London, said in a telephone interview.

“While fund of funds may add value on a gross basis, the fee drag means that the net returns are not enough to justify the risk.”

Adding Fund Managers

The pension plan has about 300 million pounds in hedge funds and expects to increase that to 1.5 billion pounds by investing on average as much as 75 million pounds in one manager a month, Powell said.

Hedge-fund managers bet on falling and rising assets prices and take a cut of profits. They charge investors fees of about 2 percent of assets and 20 percent of investment gains. Funds of funds charge 1 percent of assets and 10 percent of profits on top of those fees.

In the Netherlands, PGGM, a nonprofit that manages funds for Pensioenfonds Zorg en Welzijn, plans to move away from funds of funds and invest the 1.7 billion euros ($2.3 billion) it has in directly, according to an e-mail from Diana Abrahams, a spokeswoman. Zeist, Netherlands-based PGGM manages 87 billion euros.

Skeptics Remain

As of September 2009, public funds had about 52 percent in stocks, 29.5 percent in bonds, 16.8 percent in alternatives and 1.5 percent in cash, according to Bank of America Merrill. Corporate funds had 45.1 percent in stocks, 36.9 percent in bonds, 15.9 percent in alternatives and 2.1 percent in cash. Most pension managers include hedge funds in the alternative category.

Not all retirement plans are convinced that the funds are for them.

“We’re a conservative investor and hedge funds are too risky and flashy for our portfolio,” Ricardo Duran, a spokesman for the $134 billion California State Teachers’ Retirement System in West Sacramento, California, said in a telephone interview. Calsters is the second-largest state retirement program after the $200 billion California Public Employees’ Retirement System.

Seeking Comfort Level

Among the reasons why pension funds are hesitant to put money with hedge funds is that they lack an understanding of what they are invested in, said Daniel Celeghin, a partner at Casey Quirk.

“Some of the investment strategies that hedge-fund managers use are so esoteric that board members are saying, ‘I don’t understand this 100 percent, so let’s go slowly,’ ” he said.

Among those still reviewing the level of hedge-fund holdings is the School Employees Retirement System of Ohio, which invests about 3.3 percent of the $9 billion it manages in the private partnerships.

“Hedge funds are new to us and so we’re still trying to get comfortable with them,” said Tim Babour, a spokesman for the Columbus-based plan, which made its first investment in hedge funds in 2008.