Many Happy Returns: ‘Alternative’ Investments Buoy State Pension Plan

Rate of return exceeds projections but union officials question millions in fees paid to Wall Street

Jeff Hooke, a financial consultant for the AFL-CIO, and Eric Richard, legislative affairs coordinator for the union, talk about the state's approach to investing in the public-workers pension fund.
Just as Gov. Chris Christie and lawmakers are working on a new budget for the state’s upcoming fiscal year, officials who manage New Jersey’s public-employee pension system are busy crafting a new investment plan for the $72 billion fund.

But while Christie has proposed increasing state spending by about $1 billion, thanks to growing tax revenues, the in-house pension-fund managers are facing a significantly more difficult scenario, including an uncertain investment climate and state contributions expected to be far less than what actuaries say they should be.

Those difficulties have amped up the pressure on how the pension system is being managed on an annual basis – and also brought on more scrutiny from the more than 770,000 public workers and retirees who are counting on the pension system to fund their retirements.

Amid that backdrop, officials from the state Division of Investment, which manages the pension system on a day-to-day basis, and members of the New Jersey State Investment Council, which sets policy for the pension system, met in Trenton yesterday to go over how they plan to manage the fund’s assets during the fiscal year that begins July 1.

“We can’t control negative outcomes,” said Tom Byrne, chairman of the investment council, at the beginning of the meeting. “All we can do is try to navigate choppy seas.”

‘Alternative’ investments again?

Although the investment plan for the 2017 fiscal year has yet to be finalized, state officials said they plan to keep using hedge funds and other so-called alternative investments to help mitigate risk, even as public-employee union officials have criticized that practice as a giveaway to Wall Street.

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Not long ago, as the recovery from the last recession was booming, New Jersey’s pension system enjoyed investment returns of nearly 17 percent. But investment gains dipped below 5 percent during the 2015 fiscal year. So far this fiscal year, they’ve gone in the wrong direction altogether, with investments losing roughly 6 percent through the end of February.

Contributions from the state, meanwhile, have been only a fraction of what actuaries have calculated would be needed to restore the health of the pension system, which was underfunded by at least $40 billion as of the state’s last official accounting.

Those payment totals are also far below what Christie promised the state would contribute in a sweeping reform law that he signed in 2011. That’s because even as employees are contributing more toward the pension system as a result of the 2011 law — and as local-employer contributions haven’t slacked at all either — Christie in 2014 backed off his promise to increase state contributions over a seven-year period.

The $1.3 billion pension payment that Christie has budgeted for the current fiscal year is well short of the more than $3 billion the state should be contributing under the 2011 law, which is often referred to as Chapter 78. Although the state contribution would rise to a record $1.86 billion in the budget Christie has proposed for the 2017 fiscal year, that’s also short of the nearly $4 billion payment called for under Chapter 78.

The state’s underfunding of the pension system was cited earlier this week by Wall Street credit-rating agency Standard & Poor’s in a review of a recent state bond sale. The state’s bond rating wasn’t lowered by S&P in the review, but the state’s credit outlook was changed from “stable” to “negative.”

Rate of return tops projections

One bright spot state pension officials have pointed to is the performance of the hedge funds and other alternative investments. The returns from those investments were reviewed by the investment council during its last meeting with a consultant hired by the state explaining the alternative investments have produced a 9.2 percent return over the last five years.

That beat the pension system’s assumed rate of return of 7.9 percent, and the overall 7.3 percent rate of return the system experienced during the same five-year period, the report said. And those calculations factored in all of the fees paid to the outside fund managers, which totaled a little over $700 million during the 2015 fiscal year.

But those fees have drawn intense scrutiny from public-employee unions. They’ve maintained the state could enjoy the same or even better gains without having to pay millions to Wall Street fund managers.

The investment council yesterday invited officials from the AFL-CIO labor organization to outline the unions’ position in more detail.

Jeff Hooke, a financial consultant hired by the AFL-CIO, said hedge funds used to provide a lot more value during the 1990s, but as they’ve grown in popularity the benefit of investing in them has largely been “competed away.”

He said his own review of the New Jersey alternative-investment portfolio shows the state’s alternative investments haven’t hurt the pension system, but he added: “There wasn’t much additional benefit, either.”

“What we’re looking at is who can do it better and for a cheaper rate,” said Eric Richard, legislative affairs coordinator for the AFL-CIO.

But Byrne and other committee members pushed back, saying their focus has to be on the long term. Managing risk for the entire portfolio is also a primary goal, they said, and the alternative investments help protect against market volatility.

Moving the functions provided by the hedge fund managers to in-house staff would also mean having to hire significantly more employees and giving them the substantial resources needed to manage such specialized transactions, said council member Guy Haselmann.

“It’s completely impractical,” Haselmann said. “It’s basically impossible.”

The state officials also disputed some of Hooke’s calculations, although they pledged by the end of the meeting to exchange information and try to work out discrepancies.

“The perspective is helpful,” Byrne said. “I see this as progress, constructive.”

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