Partner Paper No. 2: All That Glitters Is Not Gold — An Examination of US Public Pension Investments in Hedge Funds

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Pyrite_(Fools_Gold)A new report by our colleagues at the American Federation of Teachers and the Roosevelt Institute has found that public pension investments in hedge funds aren’t paying off. The eleven pension systems studied received absolutely no benefit from their investments in hedge funds, with high fees eating up all of the returns and stated investment strategies failing to pan out.

The report finds that pension investments in hedge funds really turn out to be a transfer of wealth from hard-working public employees to greedy billionaire hedge fund managers.

Many public pension systems, with encouragement from their investment consultants, have made significant allocations to hedge funds, chasing the promise of superior returns and downside protection.

Our partner paper, “All That Glitters Is Not Gold – An Examination of US Public Pension Investments in Hedge Funds” examines whether hedge funds have, in fact, provided U.S. pension funds better and less correlated returns, and whether hedge fund fees are adequately disclosed and as disproportionately high as critics suggest.

In other words, the report seeks to answer the question: “Would public pension funds have fared better if they had never invested in hedge funds at all?”

Our findings suggest these 11 pension funds’ hedge fund investments failed to deliver any significant benefits. Click To Tweet

Specifically, we found that:

  • Hedge fund net return rates lagged behind the total fund for nearly three quarters of the total years reviewed, costing the group of pension funds an estimated $8 billion in lost investment revenue.
  • Despite lagging performance, hedge fund managers collected an estimated $7.1 billion in fees from the same pension funds over the period reviewed; on average, our estimates suggest that these pension funds paid 57 cents in fees to hedge fund managers for every dollar of net return to the pension fund.
  • Whereas hedge fund managers promise uncorrelated returns and downside protection, 10 of the 11 pension funds reviewed demonstrated significant correlation between hedge fund and total fund performance.

According to our analysis, hedge funds cost the average pension fund we reviewed $81 million per year in fees. These largely undisclosed fees come directly out of workers’ own retirement savings and lower future retirement income.

Overly burdensome fees can contribute to pension shortfalls, which in turn can put additional pressures on city and state budgets (for example, the current situations in Illinois and New Jersey, among others).

Disproportionately high fees are a direct transfer of wealth from taxpayers and workers to wealthy hedge fund mgrs Click To Tweet

Because hedge fund fees account for some of the heftiest fees that pension funds pay to investment managers, pension plan participants — and the teacher and public employee unions that represent them — are justly questioning whether continuing to invest workers’ retirement savings in hedge funds makes good fiduciary sense.

Thanks again to our colleagues at the AFT and the Roosevelt Institute for their strong and compelling work on these important issues.

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HedgePapers, Pensions