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November 28, 2005
Pension, hedge-fund ties a concern
Faced with growing numbers of retirees, pension plans are pouring billions into hedge funds, the secretive and lightly regulated investment partnerships that once managed money only for wealthy individuals and elite institutions.
The plans and other large institutions are expected to invest as much as $300 billion in hedge funds by 2008, up from $5 billion a decade ago, according to a study by the Bank of New York and Casey Quirk & Associates, a consulting firm.
Pension funds account for roughly 40 percent of all institutional money. While most pension plans have modest stakes in hedge funds, others have invested more than 20 percent of their assets. Weyerhaeuser, the Federal Way-based paper company, has 39 percent of its pension fund's assets in hedge funds.
In Congress, there has been a push for amendments that would make it easier for hedge funds to manage even more pension money, without having to comply with the federal law that governs company pensions.
Pension officials who have been shaken by market downturns and persistent deficits are attracted by hedge funds' promise of richer, or more consistent, returns.
But the trend has caused some consultants and academics to voice cautions. They question whether hedge funds, with risks that are hard to measure, are appropriate for pension funds, whose sole purpose, by law, is to pay out predetermined benefits to retired workers.
Source: Commodities Future Trading Commission
Those benefits are considered so crucial that they are guaranteed: Corporate pension failures are covered by the Pension Benefit Guaranty Corp., a government agency, while pension failures by governments are covered by state and local taxpayers.
Given that the benefits are paid out on a set schedule, critics wonder whether it makes sense to rely on investments whose returns are hard to predict, managed by private partnerships that disclose little about their operations and charge some of the highest fees on Wall Street.
"It's very inappropriate when the company is offering a pension plan that is guaranteed by the federal government," said Zvi Bodie, a professor of finance and economics at Boston University who writes and lectures on sophisticated investment techniques and is enthusiastic about hedge funds in other contexts.
Hedge funds make large, sophisticated investments based on the premise that by swimming outside the currents of the markets, often betting against conventional wisdom, they can outperform other investments. Hedge funds became famous in the 1990s, when managers such as Michael Steinhardt and George Soros made huge bets that sometimes produced returns of 30 percent or more.
But the surge of pension money into hedge funds is coming at a time when the returns of many hedge funds have been disappointing, raising questions about whether pensions are arriving at the party late. Hedge funds are up an average of 5.7 percent this year, according to Hedge Fund Research.
More recently, hedge funds have made headlines when they ran into trouble: Long-Term Capital Management, a hedge fund whose principals included two Nobel Prize-winning economists, nearly collapsed in 1998; and this summer, Bayou Group, a $450 million hedge fund based in Connecticut, shut down after most of its money disappeared. Its two officers have pleaded guilty to fraud charges.
Hedge funds are meant to be only for wealthy, sophisticated investors so regulators have not monitored them as they have stocks or mutual funds.
One of the first pensions to start working with hedge funds is also the nation's biggest corporate pension fund, the $90 billion General Motors fund. It started with a small test investment in 1999 and increased it to about $2 billion in 2003, said Jerry Dubrowski, a GM spokesman.
Most pension funds have modest stakes of less than 5 percent, according to a recent J.P. Morgan survey. Verizon has 3 to 4 percent of its portfolio invested with hedge funds, and is considering adding to its investment, said William F. Heitmann, senior vice president for finance.
Weyerhaeuser's big position has significant benefits for the company. Accounting rules let companies factor expected pension returns into their operating income; Weyerhaeuser's hedge-fund-laden portfolio allows it to claim expected annual returns of 9.5 percent.
For Weyerhaeuser, each 0.5 percent increase in the expected rate of return is worth an additional $21 million to the company's pretax income this year, according to Securities and Exchange Commission (SEC) filings.
Weyerhaeuser said in SEC filings that its actual pension-investment returns more than justify its assumption of 9.5 percent.
Weyerhaeuser is not alone: Eli Lilly has about 20 percent in hedge funds and the Pennsylvania state employees' pension fund has 22 percent.
Some companies and governments, such as Pennsylvania, make the argument that hedge funds are not really an asset class at all but an "asset management tool" that does not have to be disclosed as part of the pension fund's allocation to stocks or bonds.
Even as Congress has been working to shore up the pension system and strengthen the Pension Benefit Guaranty Corp., a provision to relax the pension law for hedge funds has been proposed.
The provision would raise the limit on how much pension money a hedge fund can handle before it is deemed a fiduciary under the pension law, which would require it to be more prudent and careful than is required under securities law and would bar some trades entirely. The provision was added to a broad pension bill in the House shortly before the Committee on Education and the Workforce approved the legislation.
Currently a financial institution becomes a pension fiduciary when more than 25 percent of its assets consist of pension money; the bill would raise that to 50 percent. The House bill would also change the definition of "plan assets," so that only corporate pension money would be counted, not pension money from government plans or foreign plans.
These two changes are not in the counterpart Senate pension bill that was recently approved, but they could be added during efforts to reconcile the House and Senate pension bills.
-Seattle Times-
Posted by su at November 28, 2005 11:53 AM