Tuesday, May 14, 2013

If Only Investors Learned from One Another: Cooper Union and Hedge Funds

If Only Investors Learned from One Another:  Cooper Union and Hedge Funds

As public pension plans plow their capital into alternative investments, you might expect them to draw on the experience of endowments and foundations.  However, public pensions, like many investors, are loath to rely upon the knowledge gleaned from other investors.  It is like a ship’s captain who ignores the reports from other boats because he thinks he’s the one person who can steer his vessel through a dangerous storm.  The money management business thrives because it can recycle the same products and alleged solutions to a new cadre of eager investors, even though their promises failed to materialize in the past.  I’m not sure there’s another industry that can get away with this over and over again.
Deal Problems (1999)
Cooper Union, a very fine college in New York City, is a good case study, and by no means unique in the world of endowments.  The school has been forced to charge tuition for the first time since 1902.  The school was endowed with the land beneath the Chrysler building, which provided it with the wherewithal to be tuition-free.  James Stewart of The New York Times in an article entitled “How Cooper Union’s Endowment Failed in Its Mission”[1] chronicles a variety of mistakes committed by Cooper Union, including an ill-advised building campaign. 

In this saga there are numerous causes to the school’s woes, but Mr. Stewart highlights the critical part played by hedge funds in causing Cooper Union to fall far short of its financial needs.  Public pension fiduciaries should read Mr. Stewart’s article because the rationale for alternatives sounds strangely familiar:

Its [Cooper Union’s] endowment was typical of the many endowments and pension funds that took the plunge into so-called alternative investments like hedge funds, which have lured investors with the promise of generous and steady returns in both good times and bad (emphasis added).

This is same rationale espoused by South Carolina when it took the plunge.  It is the same argument made by the Treasurer in Rhode Island as she increased her pension’s commitment to hedge funds.  And, it is the same justification used by the Treasurer in North Carolina to seek an increase in her authority to invest in alternatives.

However, the foray into hedge funds didn’t work out so well for Cooper Union.  Again, Mr. Stewart summarizes the results:

As recently as 2009, the school maintains, it ranked first among all American universities for endowment performance.

Even so, hedge funds couldn’t solve the college’s dire financial problems, and many hedge funds have been far more successful at lining the pockets of their managers than beating market averages.   

Today pension plans have “dire financial problems” and hedge funds are offering solutions.  Rather than learning from the past, the public pension plans’ trustees and professionals are convinced that they can sort through the blizzard of claims, opportunities, and risks, and employ hedge funds to help solve their difficulties.  That’s not how the public pension story is going to end.  One day, public employees and retirees will react the same way as Cooper Union’s students:

This week, angry students were occupying the president’s office in protest. They might be even angrier to learn that some of their future tuition dollars could be going to support wealthy hedge fund managers who oversee some of the school’s $666.7 million endowment.

Of course, the students’ protest came far too late; Cooper Union now has little choice but to charge tuition.  The same will be true for public employees.  By the time they realize that hedge funds aren’t the great solution, their pension benefits will have been diminished.  Meanwhile, the hedge fund industry will have taken its promises to a new group of investors.  A warning to mutual fund investors: you’re next.

[1] http://www.nytimes.com/2013/05/11/business/how-cooper-unions-endowment-failed-in-its-mission.html

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