PROVIDENCE — Labor leaders and financial experts have questioned the Rhode Island pension system’s hedge fund investments in recent years and on Thursday welcomed news that the state will offload $500 million of its hedge fund assets over the next two years.
“We have encouraged the divestment in hedge funds,” said Robert Walsh, executive director of the National Education Association Rhode Island teachers union. “We don’t think they work as promised. We don’t think the fees make sense in light of performance. And in a public pension system, we don’t think they make a lot of sense anyway due to the lack of transparency.”
The $7.7-billion Rhode Island pension fund, which pays benefits for retired public school teachers and state employees, began investing in hedge funds in 2011, the same year Governor Raimondo, then treasurer, championed pension reform legislation that cut retiree benefits in an effort to shore up the system. The fact that money that could have been used to pay benefits was going to management fees did not sit well with the union.
Academics also seem bullish on the shift, engineered by General Treasurer Seth Magaziner and approved unanimously by the State Investment Commission, from hedge funds to a package of more traditional assets.
“I think in general there has been disappointment with hedge fund returns and investors are rethinking their hedge fund exposure,” said Neil Mehrotra, assistant professor of economics at Brown University. “I think the concern with hedge funds is the fee structure and the degree of out-performance you need to get is substantial for that fee.”
Mehrotra added that most states don’t have the kind of in-house manpower to pick the few hedge fund managers who can outperform the market.
In fact, the Rhode Island’s retirement system only has three full-time investment staff, which Magaziner said Wednesday is much smaller than similar systems.
Raimondo’s move into hedge funds came as a response to the heavy losses the pension fund suffered in the 2008 financial crisis. The fund was heavily exposed to the stock market and the hedge funds were sold as a way to diversify while still generating good returns.
But Michael Ice, a finance lecturer at the University of Rhode Island who spent 30 years on Wall Street, said hedge funds, for the most part, are not a separate asset class from equities and should not be considered protection from the market.
“That’s where people break down,” Ice said. “They think hedge funds are a non-correlated asset. If they are equity, they are correlated with market.”
Rhode Island’s hedge funds included both equity and alternative investments, but Magaziner said in his experience they have functioned similarly.
The slashing of Rhode Island’s hedge fund portfolio calls into question the status of Cliffwater, the consultant that helped build that portfolio.
Magaziner spokesman Evan England said Thursday that Cliffwater’s contract with the state expires within the year and the treasury intends to put it out to bid, as it does all consultant services.
Meanwhile, Walsh, Mehrotra and Ice all said they thought the state’s 7.5 percent pension fund rate of return would have to eventually come down considering persistently low interest rates.
The state Retirement Board is re-evaluating the rate of return this spring. Lower returns would mean the state and municipalities would need to increase their contributions to maintain the system’s funding.
Pension Fund Investment Returns as of June 30
Assumed rate of return: 7.5 percent
Fiscal 2016: -0.27 percent
5 year: 5.57 percent
10 year: 4.8 percent
Assumed rate of return: 7.5 percent
Fiscal 2016: 1.88 percent
5 year: 6.63 percent
10 year: 5.26 percent
Assumed rate of return: 8 percent
Fiscal 2016: 0.35 percent
5 year: 5.74 percent for state employees, 5.71 percent for teachers
10 year: 5.14 percent for state employees, 5.25 for teachers
*All returns include fees
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