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Pennsylvania Treasurer Joe Torsella last month told the world he’d pulled the state’s money — or at least the slice he oversees — “out of all so-called hedge-fund investments, resulting in [over] $14 million in annual fee saving.”
The claim sounded familiar. I looked it up, and sure enough Torsella had announced back in April 2017 that he was moving $2.4 billion in state funds away from private investment managers into a “passive investment strategy, saving an estimated $5 million per year in fees.”
The 2017 purge was against “actively managed” stock investors. This fall’s move, dumping nearly $500 million out of hedge funds, was “the next installment,” Torsella spokeswoman Ashley Matthews told me.
This was smaller than the stocks move (just one-fifth of the assets), but also bigger (almost three times the fee savings).
The move reflects Torsella’s long-held position to put more state pension money in low-cost index funds while avoiding high-fee hedge funds.
Through a company called Aksia, a “fund-of-funds” manager hired under Torsella’s predecessor Rob McCord, Pennsylvania employed more than 50 hedge funds — such big firms as BlackRock D.E. Shaw, and Philadelphia’s PFM, as well as more obscure investors in a web of hedging strategies — to invest a slice of Pennsylvania families’ Tuition Assistance Program (TAP) money.
What does the record show? Since 2013, Aksia and its funds were paid more than $100 million by the Pennsylvania treasury — $15 million a year — in fees and shared profits (“carried interest”), for managing that not-quite-$500 million.
How’d they do? According to Treasury data, after paying those fees, the hedge funds returned an average of less than 4 percent a year over those 6½ years. That is less than the college savings plans’ long-term target for all investments, which is 6 percent a year.
Officials at Aksia, headed by a former Credit Suisse hedge fund manager (and Penn grad) Jim Vos, didn’t return calls.
Even with the hedge funds dragging them down, all TAP investments, for the year ended June 30 — including stocks and bonds and other assets — yielded 6.45 percent, beating Treasury’s target.
By contrast, Torsella’s office points out, the Pennsylvania Public School Employees’ Retirement System continues to buy hedge funds. It fell a little short of its own 7.25 percent target for that same period. Since it pays lifetime pensions, PSERS invests for a longer time period than the college fund, so it sets a higher return target.
Even with all PSERS’ investments, state and local taxpayers will be charged $4.9 billion to keep the pension fund from becoming less solvent this year. That amounts to a 35 cent surcharge on top of every dollar collected in public school paychecks — money not available for teaching or other school programs.
Torsella, who sits on the PSERS board, has argued for dropping hedge funds from state pension funds, due to their “needless complexity, fees, and risks. A focus on asset allocation, with simple and transparent index strategies, allows us to do a better job.”
Torsella formerly ran the National Constitution Center, where his board chairman was the late John C. Bogle, founder of Vanguard Group and popularizer of low-fee stock funds indexed to the Standard & Poor’s 500 and other market benchmarks.
Malvern-based Vanguard has expanded its public funds management in recent years, and serves as the main pension investor for Montgomery County, Pa.
PSERS still likes hedge funds. Chief investment officer James Grossman testified in Harrisburg last winter that the mix of hedge fund, private equity, real estate, debt and stock-index funds beat a hypothetical mix of stock and bonds over decades.
But last year PSERS was ranked 50th, out of 52 state pension funds for investment returns over the previous 10 years by the Pennsylvania Public Pension Management and Asset Investment Review Commission, headed by State Rep. Mike Tobash (R., Schuylkill Haven) and Torsella, a Democrat.
Torsella recently commended the $30 billion State Employees’ Retirement System (SERS) for new targets that will reduce its use of “expensive, illiquid” private investments to 26 percent, from 38 percent.
PSERS declines to compare its individual private-investment funds’ returns against the S&P 500, a popular stock investment benchmark.
A stocks-heavy indexed-investments strategy — like what Torsella’s Treasury or Montgomery County is buying — is vulnerable to big losses when the stock market plunges, as it did in 2008. Unfortunately for PSERS, hedge funds and other private investments have also lost value during market collapses.
In down markets, the most useful investments are in U.S. Treasuries and other conservative debt, which tend not to lose value.
But with the low interest rates of recent years — which President Donald Trump wants the Federal Reserve to cut still lower — money managers and pension funds are on a relentless hunt for profits, and worry whether there could eventually be more risk in mainstream strategies such as stock indexing, in a market downturn.