* Rhode Island has been held up as a national model for pension reform. But within Matt Taibbi’s fascinating account of how some businesses and groups are taking money they’ve made from pension fund management and using it to lobby for reductions in pension benefits is this astounding segment…
Hedge funds have good reason to want to keep their fees hidden: They’re insanely expensive. The typical fee structure for private hedge-fund management is a formula called “two and twenty,” meaning the hedge fund collects a two percent fee just for showing up, then gets 20 percent of any profits it earns with your money. Some hedge funds also charge a mysterious third fee, called “fund expenses,” that can run as high as half a percent – Loeb’s Third Point, for instance, charged Rhode Island just more than half a percent for “fund expenses” last year, or about $350,000. Hedge funds will also pass on their trading costs to their clients, a huge additional line item that can come to an extra percent or more and is seldom disclosed. There are even fees states pay for withdrawing from certain hedge funds.
In public finance, hedge funds will sometimes give slight discounts, but the numbers are still enormous. In Rhode Island, over the course of 20 years, [Edward Siedle, a former SEC lawyer] projects that the state will pay $2.1 billion in fees to hedge funds, private-equity funds and venture-capital funds. Why is that number interesting? Because it very nearly matches the savings the state will be taking from workers by freezing their Cost of Living Adjustments – $2.3 billion over 20 years.
“That’s some ‘reform,’” says Siedle.
“They pretty much took the COLA and gave it to a bunch of billionaires,” hisses Day, Providence’s retired firefighter union chief. [Emphasis added.]
* And this…
On Wall Street, people are beginning to clue in to the fact – spikes notwithstanding – that over time, hedge funds basically suck. In 2008, Warren Buffett famously placed a million-dollar bet with the heads of a New York hedge fund called Protégé Partners that the S&P 500 index fund – a neutral bet on the entire stock market, in other words – would outperform a portfolio of five hedge funds hand-picked by the geniuses at Protégé.
Five years later, Buffett’s zero-effort, pin-the-tail-on-the-stock-market portfolio is up 8.69 percent total. Protégé’s numbers are comical in comparison; all those superminds came up with a 0.13 percent increase over five long years, meaning Buffett is beating the hedgies by nearly nine points without lifting a finger.
* The Illinois Teachers Retirement System started pumping huge amounts into hedge funds a couple of years ago. From a 2011 Crain’s article…
Springfield-based TRS, the state’s largest pension provider, plans to allocate about a third of its $37.8-billion portfolio to alternative investments such as private-equity and hedge funds, a four-month Crain’s investigation of TRS holdings and practices finds. These unconventional assets typically dangle the potential for higher returns, but only because they also carry greater risks and fees. TRS is shifting its portfolio while it’s still developing an in-house risk-management system.
Gunning for bigger returns exposes the plan to the possibility of bigger losses, further jeopardizing the pensions of 362,121 former and current teachers. The system, which has just 46.5% of the assets it needs to cover promised payments to retirees, is counting on an 8.5% annual return, which many portfolio managers and investors, including Berkshire Hathaway Inc.’s Warren Buffett, say is unrealistically high. If TRS banked on a 7.75% return — the rate that two other Illinois public pensions lowered their forecasts to this year — its assets would equal only 43% of obligations. That would swell its shortfall to $50.1 billion from $43.5 billion.
* And Bruce Rauner’s former investment firm GTCR also takes a 20 percent fee, plus extras…
GTCR has managed money for years for the Illinois Teachers’ Retirement System and the Illinois State Board of Investment, the largest and third-largest, respectively, in Illinois, as well as state and municipal pension plans from the San Francisco City and County Employees’ Retirement System to the Massachusetts Pension Reserves Investment Management Board. Its funds have delivered above-average returns for Illinois, according to Preqin Ltd., a London-based investment data provider.
For its work, GTCR takes a slice of returns it reaps from business sales, typically about 20 percent, and charges management fees, up to 1.5 percent. The Illinois State Board of Investment, for instance, reports it paid $280,000 in fees last year on $85 million it has in two GTCR funds.
Combined, TRS and the ISBI have committed $252 million with GTCR since 1993.
Some folks were understandably upset with the Dixon lawyers’ big cut of the Rita Crundwell settlement yesterday, but we need to talk more - a lot more - about these insanely high fund fees. They’re essentially robbing the pension funds of needed dollars and pushing to use benefit cuts to make up the difference.
…Adding… From Bruce Rauner’s campaign spokesman…
Rich - saw your post on fees and returns provided by alternative investment vehicles.
There a few important clarifications that would provide context for your readers:
1. GTCR performance for Illinois has far exceeded the pension funds’ returns: “William Atwood, who leads the Illinois State Board of Investment and has invested the state employee pension fund’s money with GTCR…. says the board’s investments with GTCR have generated annual returns of 17.2% since 1984.” Pension fund over that same time period has been closer to 7-8%. Those are annualized returns, so GTCR has made the pension funds a lot of money.
2. Hedge funds and firms like GTCR are different types of businesses. Hedge funds are typically sophisticated (and leveraged) trading entities. GTCR invests directly in private companies and builds them for the long term.
3. The 20 percent fee is only received if/after they sell a company for profit.
Bottom line is comparing GTCR’s performance for Illinois to that of hedge funds in other states is like comparing apples and oranges.
Also, worth pointing out, as one of your commenters did, that the rate of return for pensions is after fees.