Hedge funds in trouble

Korean pension funds, including the largest - the National Pension Service - plan to up investments in alternative assets, or investments other than classic types like stocks, bonds and cash. Investments in hedge and private equity funds could generate greater yield and diversify the investment portfolios for big pension funds. Korean public funds are looking outward and beyond traditional markets for bigger returns. Korean pension funds fear they will run out money sometime in the future due to stagnancy in the working population and the rapidly aging population amid low interest rates.

But Korean pension funds appear to be merely chasing higher returns without specific investment strategies and return targets.

In finance, it is either high risk and high return or low risk and low return. Seeking high returns would accompany that much risk. If keeping the money safe is the goal, one must be happy with lower yields. There is too much at stake in placing pension funds in risky assets just because they promise big returns. Alternative investments therefore promise higher security to attract public funds. Public assets must study thoroughly if risky products can really guarantee the safety of their investments.

The Roosevelt Institute last month issued a report titled “All that Glitters Is Not Gold” to track the outcome of U.S. pension investments in hedge funds that promised absolute returns and high performance worthy of expensive fees. Researchers analyzed 88 fiscal year performance of 11 U.S. public pension funds with investments worth $43 billion, comparing year-on-year hedge fund net returns to total net returns.

The report concluded that the 11 pension funds could have saved $8 billion if they had not invested in the hedge funds that charged disproportionately high fees. The pension funds paid $7.1 billion to hedge fund managers in management and incentive fees, which amounts to 57 percent of the revenue generated from the funds. The pension funds on average paid 5 percent in fees for other investments.

The report also questioned the rule of confidentiality in service charges. Hedge and private equity funds on paper charge 2 percent to 20 percent in fees. They take out 2 percent on the investments regardless of their performance and another 20 percent on actual returns. The report called for transparent disclosure of fees the hedge funds collect.

CalPERS, or the California Public Employees’ Retirement System, last year decided to end its $4.5 billion hedge fund program citing complexity and high costs in its management. CalPERS had been the first among major public funds to tap into the niche investment vehicle. Since then pension funds around the world have joined the gold rush, with 40 percent of assets at hedge funds worth $2.7 trillion coming from pension funds - more specifically $540 billion from public pensions and $500 billion from private pensions.

But CalPERS decided to exit the market because of steep fees. It paid $40 million in fees to manage traditional investments that account for 80 percent of its assets, while the 20 percent of its investments in hedge funds cost the fund $800 million in service charges. A CalPERS official claimed the fees were obscene and concluded that the high correlation between high costs and poor performance was unassailable over longer periods. Performance by hedge funds has been mixed. The industry pitches on superior returns, but not many portfolios have been proven to be that glamorous.

According to the zombie hedge fund report by the Financial Times, two-thirds of the 25,000 registered hedge funds have closed business. The industry does not include the unsuccessful funds in the prospect for profit. Among the survivors, small-scale funds reported high yields, but many bigger ones were not that lucky either. Hedge funds therefore cannot be the alternative answer for pensions that must manage their large funds sustainably over a long period.

The Roosevelt report is the first such analysis from the consumer’s point of view. What can be more reliable - a consumer report or a marketing pitch by the supplier? Pension funds have the role to serve as a social security net. Korean players must study the changes in global trends and place the hard-earned workers’ post-retirement money in safe and sustainable investments.

Translation by the Korea

JoongAng Daily staff.

JoongAng Ilbo, Dec. 4, Page 34

*The author is an economics professor at the National University of Singapore.

BY Shin Jang-sup