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Is NJ Paying Wall Street Too Much to Manage $80B Pension System's Investments?

State argues that $600 million paid to private investment managers last year is on the money, but unions argue it’s way out of line

Tom Byrne (left), the chairman of the New Jersey State Investment Council, and Chris McDonough, director of the state Division of Investment, testifying at Thursday’s Senate Legislative Oversight Committee hearing.

New Jersey’s pension system had two straight years in the early 2000s when it lost more than 10 percent of its value due to a crashing stock market. In response, policymakers decided to diversify the pension system’s investment strategy to help protect against another wild swing.

But now, roughly 30 percent of the pension system’s total assets are in what are known as “alternative investments,” which include private equity, real estate, and hedge funds. And those investments, run by private money managers, typically require the state to pay fees that total millions of dollars each year, costs that investments managed in-house don’t incur.

In the past fiscal year, the state paid $600 million to these private money managers.

It’s those fees that drew the scrutiny of lawmakers in Trenton yesterday during a more than three-hour Senate Legislative Oversight Committee hearing that was billed as the first in a series that will be held to determine if the pension system has now overcorrected and is too heavily invested in expensive hedge funds and other alternative investments.

State pension officials made the case at the outset of the hearing that New Jersey now has the right blend of investments, and that the state’s more modest losses during the last downturn in 2008 and 2009 shows the alternative-investment strategy has been a wise one.

“The diversification into other asset classes has kept us from putting all of our eggs in one basket,” explained Tom Byrne, the chairman of the New Jersey State Investment Council, the panel that sets policy for the roughly $80 billion pension system.

But others who testified yesterday, including a pension expert who was paid by the New Jersey State AFL-CIO labor union to scrutinize the pension system, questioned whether the state is paying too much to private money managers and whether it’s even appropriate for a public-pension system to retain pricey Wall Street experts in the first place. They suggested in-house money managers could produce similar or better results at a fraction of the cost.

“The only people who are getting rich off the system are the hedge-fund managers and the alternative-investment managers,” said Adam Liebtag, who is the AFL-CIO’s representative on the investment council and is currently its vice chairman.

The questions being raised about the pension system come as the pension issue itself has been highly politicized in recent years in New Jersey. Gov. Chris Christie, a Republican who took office in early 2010, has stressed pension reform as a signature issue as he’s risen to national prominence in the GOP.

But Christie, who is now considering a run for president, has also drawn the ire of public-worker unions for going back on a 2011 promise to increase state contributions into the pension system in exchange for forcing employees to also pay more toward their pensions.

The state Supreme Court is currently considering a lawsuit filed by the public-worker unions that is seeking to force the state to make the larger payments, and a decision could come at any time.

Adding to the tension is the fact that political contributions have been made in recent years by some of the private money managers hired by the state to handle the alternative investments. Though technically not running afoul of state campaign-finance rules, the contributions have raised questions of political favoritism and cronyism.

But it was the issue of the alternative-investment fees that drew the most attention from lawmakers during yesterday’s hearing. Those fees, which are collected by the private money managers to cover basic management duties and also as rewards for good investment performance, totaled roughly $600 million during the past fiscal year, according to the investment council’s latest annual report.

Byrne said a good portion, about $335 million, was simply a percentage of the strong returns for the state that the money managers earned. So they wouldn’t have been paid the bulk of their fees if they didn’t deliver returns totaling roughly $1.8 billion, he said.

“The more we make in profits, the higher the fees are going to be,” said Byrne, the founder of Princeton-based Byrne Asset Management.

And Chris McDonough, director of the state Division of Investment, the in-house staff that manages the pension system on daily basis, ran through slides that demonstrated the state could fall short of its overall 7.9 percent assumed rate of return without the stakes in the alternatives.

Critics of the alternative investments typically cherry-pick data, Byrne said, suggesting that’s tantamount to calling former New York Yankees slugger Reggie Jackson the all-time strikeout leader without also mentioning his 563 home runs or the World Series heroics that earned him the nickname “Mr. October.”

He also cautioned lawmakers against trying to separate one investment strategy from the pension system’s overall investment plan, saying the goal is to provide the right blend to maximize returns while also protecting as much as possible against risk. Taking away some elements of the strategy could mean exposing the pension system to too much risk again, he said.

“If we have another year like 2000, the fund may not withstand it,” Byrne warned.

But Jeff Hooke, a Maryland-based pension expert hired by the state AFL-CIO, said the success New Jersey had during the past recession relative to the 2000-2001 collapse was more a function of the state’s investments in bonds than the shift to alternative investments.

New Jersey and many other states have “drunk the Kool-Aid” regarding hedge funds and other alternative investments, even as assumptions that underlie their role in a diversification strategy haven’t been proven true, said Hooke, who’s also studied state pension systems across the country.

“It’s generally a bad deal for most states,” he said. New Jersey spent $1.5 billion on fees during the 2010-2014 fiscal years, which Hooke called “a poor use of taxpayer funds.”

Rather than choosing pricey alternative investments, he said public pension systems should consider simpler index funds, and when threatened by volatility, shift assets into more conservative investments.

And Liebtag, the union representative, reminded lawmakers that in the end it’s the 773,000 current and retired workers whose retirements hang in the balance that have the most at stake in the debate.

“We’re deeply concerned,” Liebtag said.

At the conclusion of the hearing lawmakers stressed they would like to hold similar events in the future. They also called for a forensic audit of the alternative investments, something that some trustees of the individual funds that make up the pension system have also been seeking.

“Certainly there are a lot of thought-provoking questions we need to follow up on,” said Committee Chair Robert Gordon (D-Bergen).

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