By: Russ Kamp, Managing Director, Ryan ALM, Inc.
I believe that we have overcomplicated the management of DB pension plans. If the primary objective is to fund the promised benefits in a cost-efficient manner and with prudent risk, why do we continue to waste so much energy buying complicated products and strategies that often come with ridiculously high fees and little alpha?
Case in point, the HFRI Composite index reveals a -6.7% year-to-date (9/30/22) return. Worse, the 10- and 20-year compounded returns are 4.6% and 5.7%, respectively. We know that we didn’t get those “robust” returns at either an efficient cost or with prudent risk. What are these products hedging other than returns? Why do we continue to invest in this collection of overpriced and underperforming products? Are they sexy? Does that make them more appealing? Do we think that we are getting a magic elixir that will solve all of our funding issues?
Sadly, the story is even worse when you take a gander at the returns associated with the HFRI Hedge Fund of Funds Composite Index. I shouldn’t have been surprised by the weaker performance given the extra layer of fees. According to HFRI, YTD returns show a -7.2% return, while 10- and 20-year annualized returns fall to 3.4% and 3.5%, respectively. UGH! For those two time frames, the S&P 500 produced returns of 11.7% and 9.8% respectively, and for a few basis points in fees.
While pension systems struggle under growing contribution expenses and plan participants worry about the viability of the pension promise, the hedge fund gurus get to buy sports franchises because of the outrageous fees that are charged and the incredible sums of assets that have been thrown at them? I suspect that the standard fee is no longer 2% plus 20%, but the fees probably haven’t fallen too far from those levels. As Fred Schwed asked with his famous publication in 1952 titled, “Where are the Customers’ Yachts?”, I haven’t been able to find them. Unfortunately, I think that the picture below is more representative of what plan sponsors and the participants have gotten for their investment.
Don’t you think that it is time to get back to pension basics? Let’s focus on funding the promised benefits through an enhanced liquidity strategy (cash flow matching) while allowing the remainder of the portfolio’s assets to enjoy the benefit of time to grow unencumbered. This bifurcated approach is superior to placing all of your eggs (assets) into a ROA bucket and hoping that the combination will create a return commensurate with what is needed to meet those current Retired Lives Benefit promises and all future benefits and expenses.
Hi Russ: Why didn’t fund managers learn their lesson that hedge funds are expensive and risky? If I’m not mistaken the NYS Teamsters sued a manager over a hedge fund that they lost money on. I think they won the case. How do you spot a hedge fund when you look at what investments a fund fund has?
Good morning, Joe. Often the investment into a hedge fund is done through a fund structure, as separate accounts are rarely used. Given that many alternative products, such as real estate, private equity, private debt, and infrastructure, use fund structures it isn’t easy to identify those that are hedge funds. In periods such as the one we are experiencing now, HFs should be providing a diversified and uncorrelated source of returns. Regrettably, most aren’t. If you sent me the list of managers/funds, I would be happy to research if any of them are HFs. have a great day. Russ