Tuesday, April 23, 2013

Pension Funds' Embrace of Hedge Funds Will End Disappointingly

“Pensions are embracing hedge funds because they’re desperate to improve results” writes business columnist Mitchell Schnurman in today’s Dallas Morning News.  Today’s column also notes that a large public pension fund is “trying to ‘turbocharge’ results.”

Both developments are reminiscent of 1980s S&Ls in the final years leading up to the S&L crisis.  Many S&Ls, although then liquid, were insolvent.  And non-transparently so.  Many insolvent S&Ls tried to make up lost ground by attracting additional deposits using offers of above-market interest rates -- that is, pricey interest rates.  With the additional deposits, which included troubling brokered deposits, insolvent S&Ls hoped to invest aggressively and reduce or eliminate “the size of the insolvency hole.”

Depositors didn’t worry about getting their money back because of FSLIC deposit insurance.

This set of facts was a heck of a deal for a broke S&L owner, who was in essence using taxpayer money to attract additional deposits.  If aggressive investment of the additional deposits worked out, well then the S&L owner was no longer broke.  And if it didn’t work out then the S&L owner was no worse off than before, with FSLIC bearing the additional losses.

Trying to make up lost ground rarely worked.  A typical insolvent S&L lost more ground. But depositors did fine, courtesy of FSLIC.

Substitute a significantly underfunded pension plan for a non-transparently insolvent S&L.  Then fast forward 25 years:  the same result of additional lost ground can be expected eventually.

Public pension funds’ investments in pricey, fee-laden hedge funds are slow motion gradual transfers of pension assets to those hedge funds’ managers.  The slow motion, long time-lag, and occasional appearances of intermediaries mask the transfers.  But Follow the Money.

The S&L crisis ended badly.  Significantly increased investment allocations to expensive alternative investments will on average end badly, too, over the long term.

And not only for pensioners but sometimes for taxpayers.  And many will regret when pension funds embraced expensive alternative investments

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