Pension executives, as their counterparts at foundations and endowments did before them, are pouring billions into what is essentially a black box of hoped-for returns - hedge funds.
Desperate for returns above their assumed actuarial rates, officials at many of the nation's pension funds largely have accepted the opaque management style of hedge funds in return for the expectation of absolute returns in a protracted flat to negative market.
These pension executives need to reconcile the exacting disclosure they demand of conventional money managers with their apparent complacency about the lack of transparency of hedge funds.
Hedge fund disclosure is an issue with which pension funds have wrestled since their first earnest foray several years ago. It has become more important, though, now that the Securities and Exchange Commission has shown an interest in regulating hedge funds, and because of increased demands for fiduciary responsibility in the aftermath of corporate and accounting scandals.
Hedge funds have cultivated the image that they are different from conventional equity and fixed-income portfolios and deserve more latitude in terms of transparency.
Pension executives buying into that image have compromised their standards of transparency and performance evaluation to hitch a ride with the promising talent of hedge fund managers.
Disclosing positions "may hurt the manager, which erodes investors' returns, and that does not help me," Mark Anson, chief investment officer, California Public Employees' Retirement System, said, although he supports some minimum level of disclosure, according to a Pensions & Investments story..
But pension fund officials shouldn't compromise. They should demand tougher scrutiny without overly constraining their managers, without compromising their proprietary magic that leads to the expected absolute returns.
David Swensen, CIO of the Yale University endowment, according to the same story, noted that position-level returns let investors know which positions contributed to performance. Custodians, moreover, need to know positions, as part of the process of overseeing investment trades by managers on behalf of pension funds.
Pension fund fiduciaries need to know how the money is being invested, to monitor assets and the risk level. In addition, in this era of good corporate governance, a fiduciary cannot ignore details of the underlying portfolio. Issues range from voting proxies to keeping track of any potential recovery in securities litigation.
Since enactment of the Employee Retirement Income Security Act in 1974, pension executives have built a complex, valuable system of benchmarking and evaluating managers, and more recently have been building a comprehensive system for tracking the value of good corporate governance.
Hedge funds must be incorporated into, not excused from, those systems.