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Public-Employee Pension System Won’t Invest So Heavily in Hedge Funds

Unions score big victory as investment managers decide to scale back allocations by more than half

NJ State Investment Council
NJ State Investment Council

New Jersey’s public-employee pension system will significantly scale back its stakes in hedge funds over the next several months, a big victory for worker unions who’ve been lobbying hard against such investments because of pricy fees.

The decision to reduce the $72 billion pension system’s hedge-fund allocations from 12.5 percent down to 6 percent was finalized yesterday during the New Jersey State Investment Council’s public meeting in Trenton. It resolves a months-long dispute between the panel’s labor-union representatives and appointees of Gov. Chris Christie that had been preventing the council from formally adopting an investment plan for the fiscal year that began July 1.

The decision in the short-term is projected to save an estimated $127 million in fees that are charged by the outside money managers who run the hedge funds. That was immediately lauded by union officials who said the savings could be redirected to boost the efforts of in-house money managers. And as one of the country’s larger publicly run pension funds, council members said they’re hoping the move also helps to shake up a hedge-fund industry that has traditionally levied performance fees of up to 20 percent on top of standard management charges.

California’s pension system, which is the nation’s largest, decided to end its hedge-fund investments in 2014, with fees cited as a concern.

“Public funds aren’t going to pay just whatever fees they’re charging,” said Tom Byrne, the council’s chairman. “Cutting the hedge-fund allocation, I think, will send a strong message to the hedge-fund community.”

Hedge funds are one class of what are known as alternative investments, and Byrne and other council members have in the past defended such investments as an important part of a broader diversification strategy that’s aimed at protecting against the types of widespread losses the pension system has suffered during previous economic downturns by being more exposed to traditional stocks and bonds.

They’ve also maintained that since a good chunk of the hedge-fund investment fees are paid out based on performance, the state has received a good overall return when the fees are put in context.

But the state paid more than $700 million in fees to alternative-investment managers during the 2015 fiscal year, helping to fuel concerns that union officials have raised for more than a year. The unions argue there are other, less costly diversification options, especially for a publicly funded plan.

The fees have also been paid out at a time when the Christie administration has failed to make the full sate contributions into the pension system that have been calculated by actuaries even as the workers have been paying more themselves thanks to a 2011 benefits-reform law.

Union representatives on the investment council originally called for the hedge-fund stakes to be scaled back to just 4 percent of the pension system’s total investments during the fiscal year that began on July 1. But Byrne and other gubernatorial appointees favored a more modest reduction to 9 percent. And neither side had enough votes during the panel's meeting in May] to break the deadlock.

The lack of consensus forced the pension system to begin the fiscal year without a new investment plan in place, something that hadn’t happened in recent memory.

But a compromise was reached in the ensuing weeks, with both sides agreeing on 6 percent, which is a more than 50 percent reduction. In-house managers will also be tasked with negotiating more favorable fees with remaining hedge-fund managers, cutting in half what have been traditional 2 percent management charges and 20 percent performance fees.

“I don’t know if there’s ever been this kind of significant change in direction on several fronts,” said Adam Liebtag, an AFL-CIO labor-organization representative who was among those pushing hardest for the hedge-fund changes.

In addition to reducing the stakes in hedge funds, the changes to the investment plan also mean the pension system’s allocations in alternative investments will drop from 36 percent to 31 percent, which was another goal of the union representatives.

“I think we’re at a firm middle ground,” said Eric Richard, another union representative. “It’s something I’m happy to support today.”

After the meeting ended, Byrne said scaling back hedge-fund investments has been something that’s being discussed for some time, with the only question being just how much they should be cut. He also said there’s a strategy to the change – which could increase the pension system’s volatility -- to ensure “we’re not throwing out the baby with the bathwater.”

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