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NJ State Investment Council Confronts Downside of Diversification Strategy

At yesterday’s meeting, officials admit it’s tough to get free of unsavory investment; pension-fund officer calls for forensic audit of fees paid to hedge-fund managers

Tom Byrne
Tom Byrne, chairman of the NJ State Investment Council

High-interest payday lending is illegal in New Jersey, but through a complicated public-employee pension-fund investment dating back roughly a decade, government workers here have found themselves indirectly owning a stake in a controversial payday lending firm based in Texas.

Last year, the Lone Star State lender, ACE Cash Express, was forced to pay millions in fines and restitution by federal regulators.

The issue has already been brought to the attention of the panel that sets policy for the roughly $80 billion state-pension system, the New Jersey State Investment Council. But its officials said during a meeting in Trenton yesterday that even though they want out, the complicated nature of the investment means it may take some time to get free. They’re also concerned about selling at too big a loss, which would ultimately hurt the bottom line for retirees.

“We’re moving with all deliberate speed,” said Tom Byrne, the chairman of the council. “Nobody is happy with it as it is, and I just want to make that clear.”

The state’s ties to the payday lender come through a $50 million investment in New York-based JLL Partners that was launched a decade ago. The stake in the private-equity firm is just one part of a broader portfolio that the pension system has been building up as part of a diversification strategy that relies in part on investments in private equity, real estate, hedge funds, and other so-called alternative investments as a way to cushion against swings in the stock market.

Despite snags and problems, that diversification strategy proceeds apace: During yesterday’s meeting, the council allowed the state Division of Investment, the agency within the Department of Treasury that manages day-to-day operations of the pension system, to move forward with up to $1 billion in additional proposed investments in private-equity firms and hedge funds.

The issues raised by the JLL Partners investment -- including how much control the state actually has over its privately managed pension funds and how hard those investments are to turn liquid -- are just the latest to arise over the past year as more and more attention has been paid to the overall management of the pension system and its alternative investments. This scrutiny comes in the wake of Gov. Chris Christie’s decision to reduce state contributions that were pledged as part of a 2011 reform effort, even as employees have been forced to pay more.

Those reductions and years of underfunding by other governors have left the pension system at least $40 billion in debt, putting even more pressure on pension officials to maximize returns, something figures and projections released yesterday showed they have done well in recent years, though conditions are now starting to change.

After years of double-digit gains, officials warned that growth likely fell short of the pension system’s assumed 7.9 percent annual rate of return during the fiscal year that just ended on June 30. More accurate figures should be available by September.

What’s more, the $33.8 billion budget Christie signed into law in late June allocates $1.3 billion for the pension system, nearly $2 billion less than the amount promised in the 2011 law. That shortfall has come as Christie has called on public-worker unions to accept more changes to their benefits, including less generous health plans and a freezing of the current pension system in favor of a new retirement plan with features of a 401(k).

That’s drawn the ire of public-worker unions and created a politically charged environment in Trenton as Christie has joined the 2016 GOP presidential primary and unions have dug in for a long fight with the governor over benefits.

Further complicating the matter have been political contributions made by some of the private managers hired by the state to organizations with ties to Christie, who’s proven to be a capable fund-raiser both for himself and other GOP candidates around the country since taking office in early 2010. That’s led some Democrats and public-worker union officials to question whether politics is influencing investment strategy, something Byrne and other pension officials have strongly and repeatedly denied.

Amid this backdrop, the Senate Legislative Oversight Committee, which is controlled by Democrats, last month held a hearing on the special fees that are paid to private money managers who are collectively overseeing the investment of roughly 30 percent of the pension system’s assets. Those fees, including what’s known as “carried interest,” totaled $600 million during the 2014 fiscal year, when the pension payment was shorted by more than $1 billion in state funding.

And though Byrne argued the managers only made the bulk of their fees by handling winning investments -- after netting out the fees the pension system still made about $3.1 billion from its $20 billion worth of alternative investments -- lawmakers questioned whether the state could get similar returns without having to pay the fees while still adequately protecting against risk. Tom Bruno, chairman of the board for the Public Employees Retirement System, one of the individual retirement funds that make up the overall pension system, asked Byrne and the other council members during the meeting yesterday to authorize a forensic audit and cost-benefit analysis of the alternative investments to address all of the questions that have been raised.

“I think it’s time for an independent look at this,” Bruno said.

And two members of the Senate oversight panel, Sens. Robert Gordon and Loretta Weinberg, (both D-Bergen), issued a statement yesterday echoing Bruno’s call for the review.

Byrne said during the meeting that the issue would go before the council’s audit committee and Bruno’s request would be put up for a discussion during the next meeting, which right now is scheduled for September.

“I certainly want to do everything possible to assure that people feel like they are getting good value for their money,” Byrne said. “If the work of the audit committee isn’t satisfactory then we can talk about the next steps.”

But Byrne also didn’t commit outright to allowing the independent review, something that drew an immediate response from Bruno.

“I think we just keep kicking this can down the road,” Bruno said.

Their exchange, however, wasn’t the most contentious of the meeting, which lasted more than three hours. That occurred moments later when members of a group called NJ Hedge Clippers raised their own concerns about hedge-fund investments.

Group member Elizabeth Parisian said its analysis of eight fiscal years shows the state could have been more successful investing its money elsewhere. That also would have prevented the paying out of the management fees, while at the same time steering clear of the questions that have been raised by the political donations of some of the private managers.

“There are lower-cost alternatives to hedge funds,” Parisian said. But when Byrne and other council members started to pose questions about their analysis, including other investments the group would have recommended instead of the hedge funds, the exchange grew increasingly testy. Parisian said she didn’t come to “make recommendations.”

“That is our job, to make recommendations,” responded Byrne. Council member Guy Haselmann, director of capital markets strategy for Scotiabank, also weighed in, saying the analysis deserved a failing grade. But the group members interrupted Haselmann’s critique by talking over him and then abruptly leaving the meeting.

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