The Comprehensive Case Against Alternatives in a Single Article: Roger Lowenstein
Roger Lowenstein is a writer and journalist who has written one of the core holdings of my collection of books on finance: When Genius Failed: The Rise and Fall of Long-Term Capital Management (2000). He’s also written about the pension crisis and the mortgage debacle of 2008 (The End of Wall Street). When Mr. Lowenstein writes something, I read it. In a recent edition of Fortune, Mr. Lowenstein has taken on alternative investments in public pension plans. Thus I recommend you spend a few minutes reading, “How pensions make investing too complex.”
In the span of a single article, Mr. Lowenstein strikes many of themes that are the heart of this blog. He captures the role of consultants in selling underfunded public pension plans on the magic of alternative investments. He exposes the broken promises of private equity and hedge fund managers. He explains the deficiencies of calculating returns based on the internal rate of return method. And, he extols the virtues of plain-old stocks and bonds as a sensible solution to pension funding. It’s this last point that bears emphasis.
Mr. Lowenstein acknowledges that much of the foray into alternative investments is as much about dampening volatility as it is about driving higher returns. But he’s absolutely correct when he points out that alternatives don’t really tamp down volatility. Instead, they mask it. Most importantly, he asserts that public pension plans are well suited to ride out the volatility of public markets because they are funding long-term liabilities.
Nonetheless, I have two quibbles with Mr. Lowenstein’s effort. First, he places too much emphasis on the failure of investment returns for the shortfall in public pension funding. While it is true that most pension plans have failed to meet their investment expectations over long periods of time, it is the failure to properly fund pensions that has led to the deficit.
Second, I think Mr. Lowenstein goes a bit too far in suggesting that public pensions should purge all alternative investments from their portfolios. I can envision a limited role for private equity and real estate in a pension plan, especially if the fees and incentives are reduced to a more reasonable level.
Mr. Lowenstein begins his article where I will end this post. The Iowa Public Employees’ Retirement System is in the midst of a battle with KKR, one of their private equity managers. KKR has threatened to exclude Iowa from its funds if Iowa accedes to public disclosure requests made by journalists. Instead, Iowa acceded to KKR’s pressure and released heavily redacted documents. Unfortunately, Iowa is as spineless as most other public pension plans. Some public official has to tell KKR and the other alternative managers that if they are going to redact material that isn’t really proprietary, they won’t be allowed to manage money for their pension. So far no one has had the guts.