By GRETCHEN MORGENSON
Today’s low-interest-rate environment has made the hunt for investment income tougher than ever. Many overseers of public pension funds, desperate to bolster returns and meet ballooning retiree obligations, have turned from traditional investments like stocks and bonds to hedge funds and private equity.
These so-called alternative investments now account for almost one-quarter of the roughly $2.6 trillion in public pension assets under management nationwide, up from 10 percent in 2006, according to Cliffwater, an adviser to institutional investors. Investments in public companies’ shares, by contrast, fell to 49 percent from 61 percent in the period.
Fans of alternative investments argue that they can generate higher returns. But the increased risks, higher fees and lack of transparency associated with such investments make them problematic. A 2007 paper by Fiona Stewart at the Organization for Economic Cooperation and Development in Paris said that “lack of transparency makes the level of risk and type of exposure hard to gauge” in hedge funds.
Last week, an investigation of the Rhode Island pension system’s recent foray into alternative investments raised fresh questions about the high costs and considerable risks of investing in hedge funds and whether their returns are indeed worth it.
The investigation, by Benchmark Financial Services, a forensic firm hired by a Rhode Island council of the American Federation of State, County and Municipal Employees, concluded that the $7.7 billion Employees’ Retirement System of Rhode Island was at risk because of its increased concentration in high-cost and opaque alternative investments. The union represents workers whose pensions are invested by the state.
In less than two years, the Rhode Island pension system has ramped up its investments in hedge funds, private equity and venture capital from zero to almost $2 billion, or more than one-quarter of its assets under management. But this mix of investments hasn’t outperformed the fund’s peers, the Benchmark report said. For the year ended June 30, 2013, the fund returned 11.07 percent, versus 12.43 percent earned by the median public pension fund.