Friday, April 26, 2013

Rhode Island is Following South Carolina into Alternative Investment Abyss

Rhode Island is Following South Carolina into Alternative Investment Abyss

Alternative investment managers are continuing to exploit the last great marketing opportunity: public pension plans.[1]   Sadly, Rhode Island has fallen into this trap, and State Treasurer Gina Raimando is vigorously fending off critics.   Edward Siedle, the founder of Benchmark and a contributor to Forbes, has done an excellent job of pointing out the expenses and pitfalls of Rhode Island’s foray into alternatives.[2]  Rather than restating his analysis, I recommend reading his posts for a thorough critique.   Predictably, Treasurer Raimando is attacking Mr. Siedle.  She’d do her pension plan a lot of good by answering his questions.  She might begin to understand that alternatives aren’t the answer to the pension’s woes.  The only clear winners are going to be the money managers.  Treasurer Raimando was, before she was elected to office, the founder of a venture capital firm.
Selling a Discard (1999)
You only have to go to South Carolina to see how this story will end.  South Carolina plowed their pension into alternatives, driving up their fees without improving performance or risk. In South Carolina, a new Treasurer, Curtis Loftis, challenged their Investment Commission’s decisions.  For his efforts, Treasurer Loftis has faced a withering attack from the SC Investment Commission.  Sadly, a future Treasurer in Rhode Island will probably wind up waging the same uphill battle.  Rhode Island could have saved a lot of money by spending just a little time perusing South Carolina’s annual report and the public reports about their foray into alternatives.

Alternative investments can play a positive role in an investment portfolio.  However, when they are applied at a large scale as they are being applied in Rhode Island, South Carolina, and elsewhere, any benefit disappears.  As I mentioned last week (“Lessons from CALPERs: Taking the Long View [April 17, 2012]”), CALPERs is reconsidering its commitment to hedge funds and the size of its exposure to private equity.  Rhode Island is going to find out what CALPERs has learned from long experience; its pension plan will simply be left with a big bill. 

As a reminder, the management fee, which has stirred up debate in Rhode Island, is only a fraction of the cost.  In addition to paying 1.5% to 2% in management fees, the Rhode Island pension plan faces hidden costs (quietly deducted from their investment) in the form of trading costs, carried interest, and various fund expenses.  When it’s all said and done, 35% to 40% of any gains will go to the money managers and Wall Street.  You can guess who loses.

There’s an enormous irony in this saga.  The very alternative managers who are winning assignments with public pension plans are, at the same time, attacking them.  While they are happy to manage a nice chunk of a pension plan and earn a healthy fee, they are attacking defined benefit plans, advocating for defined contribution plans, and otherwise railing against government employees.  Rhode Islanders, and particularly their civil servants, would be well advised to keep a watchful eye on their Treasurer and her relationships with money managers.


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