Most Liberty Blitzkrieg readers will be familiar with the common fee structure for hedge funds known as “2 and 20.” What this simply refers to is the fact that a manager will take as a fee 2% of the assets under management, as well as 20% of the profits (above a high-water mark). While many people would balk at giving up such a high percent of profits, when the industry first got going several decades ago the managers were so few and the returns so huge, that high net worth individuals were happy to pay up for alpha.
Fast forward several decades, and the hedge fund industry is extremely crowded and competitive. What’s worse, in such a central bank manipulated market, it has become extraordinarily difficult for hedge funds to outperform and generate the desired “alpha.” Nevertheless, people that go into this business generally go into it for one reason. To make a shit-ton of cash.
So in a world of poor performance, the hedge fund industry needs to earn more from the 2% and less from the 20%. In this reality, performance actually takes a backseat to assets under management. As long as you can get your assets under management high enough, you can earn hundreds of millions on fees alone. After all, 2% of $10 billion = $200 million per year in fees.
In such a world, you are less focused on alpha, and more focused on mediocrity and simply surviving. Growing assets becomes priority number one, and everything else is a far distant second. In light of that, there’s no better way to grow assets under management without having to find high wealth individuals than targeting pension funds. State pensions, city pensions, it doesn’t matter. What better way to inappropriately match up the risk profiles and savings of low income people with “alternative investments”?
It’s not just hedge funds of course. In fact, the devious practices of private equity firms often makes the hedge fund industry look like choir boys, as evidenced by a former SEC official who claimed 50% of private equity audits reveal criminal behavior. The subject of public pensions investing in alternative investments has been a key topic for me during 2014, since I believe it will be at the center of the next financial crisis. Here are a couple of articles to get up to speed:
Meet Janet Cowell – The North Carolina Treasurer Desperately Pushing to Keep Criminal Public Pension Fees Secret Leaked Documents Show
How Blackstone Fleeces Taxpayers via Public Pension Funds
While financial oligarchs are feasting on massive fees from this captive pool of capital, the savings of lower income Americans are potentially being put at great risk. Fortunately for us, journalist David Sirota has zeroed in on this subject like a hawk. Sirota is relentless and courageous. Unafraid to successfully take on brutish and powerful leaders such as New Jersey’s Governor Chris Christie and his involvement in the recent pension scandal, which he broke. His articles have been the source of many of my posts highlighting the topic this year.
What’s so important about Sirota’s work is that it is having an actual impact and making a difference. The latest example of this is his expose about how the San Francisco pension fund was taking advice on whether to invest $3 billion in hedge funds from a consultant who himself is a hedge fund manager. You can’t make this stuff up.
International Business Times covered this two days ago, right before a vote on how to allocate the capital took place:
This week, officials in San Francisco may vote on a proposal that could shift billions of dollars of the city’s pension portfolio from plain vanilla investments such as stocks and bonds into hedge funds that charge substantially higher management fees. As they mull that move, municipal pension overseers are drawing on the counsel of a company called Angeles Investment Advisors, one of a crop of consulting firms that has emerged across the country in recent years to aid municipalities in navigating the murky waters of managing money.
For two decades, Angeles has been employed by the San Francisco pension system to champion the best interests of city taxpayers and employees — the cops, firefighters and other municipal workers who depend on pension payments after their retirement. But the firm is concurrently playing another role that complicates its image as a disinterested guide: An International Business Times review of U.S. Securities and Exchange Commission documents has found that since 2010, Angeles has run a hedge fund based in the Cayman Islands that invests in other hedge funds.
In other words, the consultants that are supposed to be providing unbiased advice about whether San Francisco would be wise to entrust its money to the hedge fund industry are themselves hedge fund players.
This summer, San Francisco pension officials asked Angeles to analyze the hedge fund initiative by SFERS investment officer William Coaker. The city’s pension system is 92 percent funded and considered financially healthy, but Coaker is proposing a major change of strategy. His plan, which could be voted on this week, could shift up to 15 percent — or $3 billion — of the city’s portfolio into hedge funds, at a potential cost of more than $100 million in additional annual fees paid to private hedge fund managers.
Angeles also declined an IBTimes request to release the text of the contract it signed with the city, and SFERS staffers and most trustees did not return IBTimes calls regarding any disclosures in the agreement. One trustee replied with a refusal to comment. And trustee Herb Meiberger, a San Francisco State University finance professor who has been elected to the city pension board since 1992, said his fellow trustees have not been provided any explicit disclosure about Angeles’ hedge fund connections, even as the firm has guided the board’s debate about hedge funds.
“I have no recollection of Angeles managing hedge funds disclosed or reflected in the minutes of any board meeting,” said Meiberger, who opposes the hedge fund investment proposal. “I have no recollection of any written document or memo stating that Angeles manages hedge funds. They have not provided that.”
Although reading the above might make your stomach turn, there’s some good news here. Likely as a result of Sirota’s work, the San Francisco pension has decided to hold off on the hedge fund investments. We learn from today’s Investors Business Daily that:
San Francisco officials on Wednesday tabled a proposal to move up to 15 percent of the city’s $20 billion pension portfolio into hedge funds. The move came a day after International Business Times reported that the consultants advising the city on whether to invest in hedge funds currently operate a hedge fund based in the Cayman Islands.
The hedge fund proposal, spearheaded by the chief investment officer of the San Francisco Employees’ Retirement System, or SFERS, had been scheduled for action this week. If ultimately enacted, it could move up to $3 billion of retiree money from traditional stocks and bonds into hedge funds, potentially costing taxpayers $100 million a year in additional fees.
Pension beneficiaries who oppose the proposal spoke at Wednesday’s meeting of the SFERS board. They cited financial risks and the appearance of possible conflicts of interest in objecting to the hedge fund investments.
Well done Mr. Sirota.
In Liberty,
Michael Krieger
Protect your wealth – Buy Gold and Silver Bullion with Goldbroker.com
Donate bitcoins: 35DBUbbAQHTqbDaAc5mAaN6BqwA2AxuE7G
Follow me on Twitter.
Since the SEC stopped turning a blind eye to the hedge funds’ insider trading, the hedge funds – oddly – have done rather poorly in comparison to the index funds.
eventually , years from now, pensioners will panic sell everything. and by then, they will be frank-dodded, american speak for ‘cypressed’.
and rinse wash repeat—qe.x is coming on a periodically accelerating rate—until some sort of socio political singularity.
There couldn’t be any kickbacks going on between pension fund managers and hedge fund managers, COULDTHER?
http://pension360.org/the-lawsuit-that-could-legalize-pay-to-play-for-pension-fund-invesments/
Here is a summary from the October 8 Retirement Board’s meeting:
William Coaker (the CIO) affirmed that hedge fund managers accurately represent their performance and strategies. Commissioner Meiberger disagreed, citing Securities and Exchange Commissioner Drew Bowden’s remarks on the SEC’s two-year investigation of hedge funds, finding cases “where potential investors were given only the most favorable description of past performance rather than full disclosure of winning and losing bets”, and “examples of hedge funds presenting modeled or back-test performance as actual results and flipping between valuation methodologies”, and “illegal collection of fees or severe compliance shortfalls in more than half of the firms it has examined since 2012”.
Herb Meiberger, CFA
Excellent Herb, thank you very much for sharing this!