Public pensions eyeing hedge funds

Riskier investment seen by some managers as way to make up losses

NEW YORK - Public pension funds are increasing bets on high-risk hedge funds and real estate in an attempt to fill deficits in retirement plans and make up for their worst performance in six years.

New York comptroller Thomas DiNapoli is asking lawmakers to increase a cap limiting the amount of alternative investments in the state's Common Retirement Fund, the third-biggest US public pension at $153.9 billion. South Carolina's retirement system adopted a plan to invest as much as 45 percent of its $29 billion in hedge funds, private equity, real estate, and other alternatives that weren't tapped at all 18 months ago.

"We need some more flexibility," DiNapoli said Aug. 4.

Public funds are trying to plug deficits and reverse losses that Merrill Lynch & Co. says averaged 5.1 percent in the year ended June 30. Yet in reaching for high returns while diversifying their assets, managers may be putting taxpayer money at risk at a time when the economy is growing at its slowest pace since 2001.

"It doesn't come risk-free," said Susan Mangiero, president of Pension Governance LLC, a research firm in Trumbull, Conn.

Massachusetts Pension Reserves Investment Trust lost $80 million in the last two years as Greenwich, Conn.-based Amaranth Advisors LLC closed and Sowood Capital Management LP of Boston imploded, according to reports last year. New Jersey's fund lost about $15 million when Amaranth Advisors LLC collapsed.

Alternative investments include private equity, hedge funds, real estate, and commodities. That category is expanding to include timber and infrastructure.

Chicago-based Hedge Fund Research Inc.'s weighted composite index, based on data from more than 2,000 funds, fell 2.4 percent in July and 3.5 percent year-to-date, which would be the worst annual performance since at least 1990. Hedge funds are private, largely unregulated pools of capital whose managers can buy or sell any assets and participate in profits from money invested.

While states and local pension plans have invested in alternative assets for more than a decade, the trend is accelerating as returns on stocks and bonds sag.

"The last couple of years have not been particularly good for equity markets, and plan sponsors are looking for ways to make up the difference," said Kurt Winkelmann, the head of global investment strategy at Goldman Sachs Asset Management.

Public pension funds are already overestimating their future performance, according to a survey of 147 retirement systems by Greenwich Associates. The Greenwich, Conn., consulting firm found in April that fund managers forecast outperforming market benchmarks by 1.46 percentage points over the next five years, an outcome it called unlikely.

States owe about $2.35 trillion in pension payments over the next 30 years, the Pew Center on the States said in a December report. Based on 2006 figures, the funds were short about $361 billion.

DiNapoli wants the New York fund, which doesn't have a deficit, to be authorized to invest more than 25 percent of its assets in alternative investments. The fund gained 2.6 percent in the year through March - its worst since 2003.

The Austin-based Teacher Retirement System of Texas said in May it will increase investments in alternatives to 30 percent from 11 percent over the next several years.

New Jersey expects to increase its alternative investments to 18 percent of its holdings from 11.5 percent, said William Clark, director of New Jersey's Division of Investment.

New Jersey's system, which has $77.7 billion in assets, earned 36.6 percent on commodities in the year ended June 30, partially offsetting a 10.3 percent loss on domestic equities.

"The risk is that if there is this rush to get into alternatives, investors could get crowded out," losing access to managers, Clark said.