Jan. 19–Does money grow best in the dark?
At a time when securities cops and small investors are demanding more accountability in the financial markets, Pennsylvania’s state pension fund is following some other big institutions in hiring unregulated investment managers whose methods are deliberately obscure.
The $24 billion State Employees’ Retirement System is moving billions from familiar, transparent, government-regulated stock-index funds to hedge funds, whose managers don’t have to report what they do with clients’ cash.
It’s a strategy that attempts to make money even in down market years, says SERS chief investment officer Peter Gilbert.
Does SERS know where this money is actually going? “We get aggregate numbers,” but not detailed investment lists, from hedge managers, Gilbert said.
“We recognize there’s not the disclosure you get in more traditional market activities,” he added. “Some give you almost no disclosure, others almost total, others on a lagged basis, others only if you go into their office.”
But SERS believes the wide range of hedge funds its managers buy reduces the overall risk.
Limited to wealthy investors, hedge funds are free from regulations, reporting and restrictions that apply to mutual funds and other registered investments. They typically bet on strategies such as short-selling (betting that a stock’s price will drop) and arbitrage (exploiting small price gaps) to “take advantage of anomalies in the financial system,” said Gilbert.
Lured by high fees, scores of money managers have quit mutual funds and other traditional portfolios to run hedge funds in recent years.
SERS pays pensions to 91,000 retired legislators, judges and other state workers, funded by a mix of investment profits and taxpayer subsidies.
In 2002, SERS invested $2.5 billion in four hedge funds that spread their money among other hedge funds (“funds of funds”) in an effort to make money (for a positive “absolute return”) even when stock prices dropped.
Is this working? The value rose to $2.8 billion by the end of 2003, but the four hedge funds’ collective return trailed the increase in SERS’ overall investment portfolio by about 50 percent.
Still, Gilbert said he was encouraged by the prior performance of U.S. hedge fund managers, who claimed modest profits during the market’s 2000-2002 downturn.
The SERS board, headed by Philadelphia attorney and former State Rep. Nicholas Maiale, voted in December to double its hedge-fund target to 20 percent of the system’s total assets over the next two years. The City of Philadelphia pension system also is looking for hedge managers; the larger New Jersey state and Pennsylvania teachers’ funds are weighing such a move.
Hedge investors have plenty of company, including big universities such as Harvard and Yale. Total assets of hedge funds managing $10 million or more each rose from an estimated $27 billion in 1994, to $214 billion last year, according to hedge-fund tracking firm CSFB/Tremont Index LLC.
Hedge funds are hot today, like venture capital was in the 1990s and commercial real estate in the 1980s. Hedge investors hope this bubble doesn’t burst.
The four hedge fund pools with SERS money are:
–Blackstone Alternative Asset Management, New York ($750 million invested by SERS in 2002).
–Mesirow Advanced Strategies Inc., Chicago ($575 million).
–Morgan Stanley Alternative Investment Partners, New York and West Conshohocken ($575 million).
–Pacific Asset Management Co., Irvine, Calif. ($575 million).
What do those funds do with SERS’ taxpayer-subsidized investments?
Blackstone Alternative Asset seeks “risk-adjusted returns with low volatility and low correlation to traditional asset classes,” says its brief online sales brochure.
What does that mean? “If you want to speak about the fund itself, we cannot possibly do that,” said spokesman John Ford.
Mesirow advertises “nontraditional investment strategies” that “provide meaningful diversification to an existing core portfolio.”
Founder Howard Rossman promised to explain, then said he was too busy. Rossman holds a Ph.D. from the California Institute of Integral Studies, whose mission is to “embody spirit, intellect and wisdom in service to individuals, communities and the Earth.”
Morgan Stanley Alternative advertises a “liquid markets fund of funds strategy.” A flier distributed by the Harvard Business School Club of Philadelphia for a November talk by a Morgan Stanley Alternative manager stated that funds similar to those managed by the firm “are delivering a 5-year IRR [Internal Rate of Return] of over 80 percent even in today’s conditions!!!” Morgan spokeswoman Andrea Slattery declined comment.
Pacific Alternative’s Web site says that firm invests in convertible bonds, foreign debt, mortgage debt, distressed debt, merger arbitrage and short sales. Founder Jane Buchan did not return a call.
Officials at Blackstone and Morgan Stanley have made small donations to Gov. Rendell and, in Morgan’s case, several other candidates in Pennsylvania elections since 2000. SERS says it picks investment managers based on competence, not cash or connections.
Joseph N. DiStefano can be reached at 215-854-5957 or jdistefano@phillynews.com.
—–
To see more of The Philadelphia Inquirer, or to subscribe to the newspaper, go to http://www.philly.com
(c) 2004, The Philadelphia Inquirer. Distributed by Knight Ridder/Tribune Business News.
MWD, PA,
