New jersey to hedge funds: Stop making us money

May 25, 2016 01:00 PM

Hedge funds and alternative investments netted the New Jersey public employees’ state pension system a five-year annual return of 9.2%, beating the 7.9% return that was initially projected. 

That’s net of fees paid to the funds to manage their money, which totaled $701.4 million. It’s a big chunk of change, which is why the AFL-CIO argues that management costs are too high and it’s time for someone else to manage its money. 

Right now, the union says it wants to cut back on the amount put in alternatives in order to save money. The AFL-CIO is not the only set of pensioners in the country to make similar statements, take similar action or who are similarly math challenged. 

But here’s where it gets funny: They want the same performance at a fraction of the cost.

“What we’re looking at is who can do it better and for a cheaper rate,” said AFL-CIO legislative affairs coordinator Eric Richard in March. According to the union, they ultimately want “to mirror risk/return attributes with lower fees” and manage pubic equity investment in-house.

A reasonable goal, and the State has a choice as to where to put their money, but the union appears to be more worried about who gets the fees than how much they are. New Jersey AFL-CIO President Charles Wowkanech said, “Let’s stop making Wall Street millionaires into Wall Street billionaires and return to a responsible, traditional allocation of stocks and bonds.”

In 2015, the overall pension fund would have seen losses of 1.88%  (the traditional allocation Wowkanech asked for) if it hadn’t been for the 5.6% in gains offered by alternative asset managers. The AFL-CIO leaders didn’t have to invest with hedge funds or in liquid alternatives. They could have put the fund in a savings account and received 0.1%. To mitigate risk, they could have bought gold. An S&P 500 tracking fund would have offered a loss of 0.73%. But they can’t expect the same rate of return to magically appear by eliminating the asset class that produced it. If they don’t like the fee, they should invest elsewhere, but in something else capable 

Still, compared to the $1.2 billion that the state has spent on a tunnel to nowhere (stalled Hudson River project), that $701.4 million on hedge funds seems like a bargain. At least there was a return to tax-paying union members.

Fiscal insanity

If you run a web search of the term, “New Jersey is last in…”, you return with 1,840 Google results. 

The most outrageous is the fact that New Jersey has the highest cost per mile when building new roads of any state in the Lower 48 – a staggering $2 million per mile. That’s not asphalt that people are driving on, it’s wasted taxpayer money.

That’s 12 times the national average just to build a road. While the commissioner of the New Jersey Department of Transportation has argued that estimate is wildly inflated, he never disclosed the actual figure.

New Jersey residents don’t have a choice when it comes to who builds the roads and how the state manages their money. Perhaps that’s one of the reasons why hedge fund manager David Tepper just announced that he is relocating to tax-friendly Florida from New Jersey in 2016. Tepper is the richest resident in the state, and his departure grabbed headlines. It has fueled concerns about the state’s economic revenue and a legislative freak out over the expected blow to state coffers. 

The state has some of the highest property tax rates in the nation. It’s the only state that has issues an inheritance and an estate tax, its top income tax rate is 8.97% and residents aren’t allowed to deduct charitable gifts on their state tax returns. They need every penny they can get, and it still won’t be enough. 

The debate over whether hedge fund managers should pay more in taxes is worthwhile. But like many governments, they rely on 20th century tax policy to solve a 21st century problems, or they create new rules and regulations designed to paper over loopholes created by previously misguided regulation (see “Dems antidote to the evils of activist investing,” page 28). 

For New Jersey, something is going to give. If it continues to lead U.S. states in residents relocating elsewhere and its operators turn their backs on reliable money managers it will get uglier.

New Jersey’s pension fund already has roughly $75 billion in unfunded liabilities. Some estimates place that figure much, much higher.

New Jersey pension recipients don’t need a cheaper hedge fund manager. They need to be one of the first entrants of a Ponzi Scheme to get the rates of return required to bailout their unsustainable pension plans.

About the Author

Garrett Baldwin is the Managing Editor of the Alpha Pages and the Features Editor of Modern Trader. An author and Baltimore native, he earned a BS in journalism from the Medill School at Northwestern University, an MA in Economic Policy (Security Studies) from The Johns Hopkins University, an MS in Agricultural Economics from Purdue University.