HARRISBURG, Pa. - As the big kid on the pension fund block, CalPERS and its $149 billion in assets may get most of the attention, but in reality, the $24 billion Pennsylvania State Employees' Retirement System is leading the public pension fund charge into hedge funds.
PennSERS, working with consultants Rocaton Investment Advisors LLC, Darien, Conn., and Cambridge Associates LLC, Boston, in just less than a year has researched hedge funds, studied how they fit into its overall portfolio and invested nearly $3 billion.
So while the California Public Employees' Retirement System, Sacramento, may have started the ball rolling with its pledge in 1999 to eventually invest up to $1 billion in hedge funds, PennSERS has left it in the dust when it comes to actually investing the money.
PennSERS' board of trustees earlier this year heard presentations from several consultants and prospective hedge fund-of-funds managers. Then at its April meeting, the system allocated $575 million each to absolute return fund-of-funds managers Blackstone Alternative Asset Management, New York; Pacific Alternative Asset Management Co., Irvine, Calif.; and Morgan Stanley Alternative Investment Partners, New York.
A month later, in May, the board approved another $575 million allocation, this time to Mesirow Advanced Strategies Inc., Chicago. Add all that to an earlier investment of $200 million in a fund of funds run by Blackstone, and PennSERS' total hedge fund investments were suddenly $2.5 billion, or roughly 10% of its total portfolio.
Few people in the hedge fund industry can think of a single public pension plan with a larger percentage of its assets invested in hedge funds than PennSERS, not even the giant and closely watched CalPERS.
"You hear of foundations and endowments making that kind of allocation, but not so much public funds," said Bruce Lipnick, founder, president and chief executive of Asset Alliance Corp., a New York-based fund of funds.
"I haven't heard of any other public funds with that high an allocation," said Kelsey Biggers, managing director of risk management at New York hedge fund of funds K2 Advisors.
None of this is lost on PennSERS officials. And none of it bothers them, either.
"We do have a good bit of alternative investments, perhaps higher than the other funds, but not as high as the Harvards and other endowments," said Gibson E. Armstrong, PennSERS trustee. "We've probably been more aggressive over the years than other funds, but it's worked well for us."
Mr. Armstrong, who is also a Republican senator in the Pennsylvania General Assembly, said the fund's size allows it to hire the "best of the best" when it comes to alternatives managers, and hedge funds are no exception.
Laying the groundwork
Nicholas J. Maiale, a Philadelphia attorney and chairman of the PennSERS board of trustees since 1994, said the plan did a lot of work before investing in hedge funds.
"Staff and the consultants did a tremendous amount of research," he said. "There was a feeling that if we're going to do it, let's do it right. Let's not just put one toe in the water. We wanted to get ahead of the curve, and not be last in line or in the middle of the pack."
Mr. Maiale said he read up on hedge funds in 2001 and became concerned about the number of institutions moving into the area. He wanted to avoid being just another in a long line of timid investors.
"I feel we've addressed that by going in early, and with the size of our commitment," Mr. Maiale said.
PennSERS apparently wanted a hedge fund investment large enough to have a tangible effect on the portfolio, Mr. Lipnick said. "They may be on the high side, but it probably works for them. They obviously wanted to invest enough to make an impact."
Mr. Maiale agreed, but he denied that this year's hedge fund investments were in any way tied to a recent U.S. Census Bureau report that said PennSERS and the $46 billion Pennsylvania Public School Employees' Retirement System, Harrisburg, combined lost more money in 2001 than any other pension system in the country. In fact, he characterized the census report as "totally incorrect."
In response to that report, officials at the two Pennsylvania funds sent out a press release saying the state's audited financial statements showed 10-year annualized returns of 10.5% for the state employee plan and 9.8% for the public school employee plan through Dec. 31, both despite one-year losses in 2001 of 7.9% and 5.9%, respectively.
By comparison, the median return for public master trusts larger than $1 billion was -5.19% for the year ended Dec. 31, according to the Trust Universe Comparison Service of Wilshire Associates Inc.. The 10-year annualized TUCS median return for the period ended Dec. 31 is 9.8%.
Pennsylvania officials said the census figures also differed from other states' audited figures, casting doubt on the accuracy of the census numbers.
"Given a choice between the states' own audited financial statements, and the Census Bureau's aggregate figures, it would be prudent to assume that the states' audited financial statements are the more reliable source of information," Pennsylvania officials said in the news release.
PennSERS seems light years ahead of the average public pension fund when it comes to hedge fund investing.According to information cited by hedge fund information broker Infovest21 LLC, New York, the average public pension fund has allocated only 3.1% of its portfolio to alternatives in general, including private equity and venture capital. As of Dec. 31, the most recent figure available from the state and prior to its allocation to hedge funds, PennSERS had 10% its portfolio allocated to alternatives, excluding real estate to which the plan had allocated 10.3% as of Dec. 31.
Going into hedge funds so heavily and so much earlier than others could open up PennSERS officials to more of the kind of criticism they received in April, when the Philadelphia Inquirer reported that some experts were critical of the plan's venture capital investments. The story, headlined "Gambling Big with Pa. Pension Funds," cited combined investment losses of $15 billion over the past two years for the state employee and public school employee plans, and suggested those losses had driven the funds to invest more money in more risky strategies like venture capital.
Venture capital's 2001 return through Dec. 31 was -27.8%, according to Thompson Financial Venture Economics, New York.
Mr. Maiale dismissed such criticism, although he acknowledges that poor returns last year and the likelihood that things aren't going to get much better anytime soon helped make the plan's decision to invest in hedge funds a little easier. Last year's return was well below the state employee plan's 8.5% actuarial assumption.
So far, this year isn't looking much better, and hedge fund strategies generally have performed better than broader traditional market indexes. As such, PennSERS officials are hoping they can bridge the gap between poor returns and the plan's actuarial assumption.
This year, the CSFB/Tremont hedge fund index is up 1.3% through June 30, compared with the S&P 500, which is down 13.2% for the same time period. The Van U.S. hedge fund index is unchanged through June 30. The Hennessee hedge fund index is down 1.5% for the six months through June 30.
Mr. Maiale said he's confident in the PennSERS staff's research, the consultants' recommendation and the board's decision to invest in hedge funds.
"Everyone recognized that we needed to move in another direction, given everything that's happening," he said.
"We have a pretty involved board, and we were ahead of the curve on a number of asset classes - private equity, real estate. We've generally been pretty forward-thinking."