Riley: Institutional Investor Gives Bad Grades to RI's Hedge Fund Picks

Riley: Institutional Investor Gives Bad Grades to RI's Hedge Fund Picks

February 2015 has seen a big rally in the Stock Markets around the world helping stem the losses in our Pension Funds Statewide. Some indexes have gained 5% or more.  Despite these big gains, our tracking shows the State Pension Fund will underperform this month and will remain badly lagging the market for fiscal year 2015 which ends June 30, 2015. It has been no secret that those managing the State Pension Fund former Treasurer Gina Raimondo and now Seth Magaziner are adherents to Modern Portfolio Theory and enjoy wielding a massively complex portfolios filled with fees. Over 100 different external asset managers and a handful of advisors and consultants have produced the portfolio you see today.

You can easily see how complex this portfolio is. Unfortunately there are no guarantees in life or the stock market and things can go wrong. Does RI management team have a plan B? Relying on professional consultants who consistently make the same mistakes as individuals, by weighing too heavily past performance of large politically influential hedge funds and not valuing low cost indexing, ETF’s  and hedging. The State has underperformed its discount rate and the market for nearly a year now. What happens if negative interest rates come to the U.S.? Or Oil goes to $25 or $125?  Has the portfolio become so complex that they can’t outperform most scenarios?

Why is the State underperforming?

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Last week came news that would have been very surprising to retirees and state taxpayers alike. That is if anyone actual reported on this $8 billion dollar pension fund that our new treasurer is managing in trying to support $12+ billion in liabilities. The news was that Institutional Investors released its 2015 ranking of the 100 largest Hedge Funds. 

They were ranked by 8 metrics and finally given grades “A to F”. In 2015 there were 4 “F” grades and a few “D” grades according to Institutional Investors. 

Rhode Island picks clunkers

Somehow our $800,000 per year hedge fund consultant “Cliffwater” managed to recommend one “D” rated fund and one of only 4 “F’s” in the survey. Blue Crest Capital, rated “F”, was chosen by RI Investment Advisory Board, Gina Raimondo, and Anne Marie Fink. In addition to this disastrous pick they also select Brevan Howard who received a “D” rating from institutional investors. These rating are significant because the only votes on this survey come from current Institutional Investors who have money managed by those hedge Funds. It would be interesting to know If Ann Marie Fink or Seth Magaziner think these two poorly rated funds are performing well or if they could ask their consultant “Cliffwater” what is going on?  Blue Crest Capital charges a 2% management fee plus a 20% performance fee while Brevan Howard is 2% and 25%. The total fees paid to all hedge fund managers by the State of RI pension fund in FY 2014 was $46 million dollars. 

From January 2012 Blue Crest has received $1.75 million in fees and Brevan Howard, over the same time period, has earned $5.13 million in fees. Blue Crest Capital has returned a paltry 1.59% in FY 2014 and since inception returned only 1.93%. Brevan Howard was even worse despite the $5 plus million in fees over the last 3 years. Brevan Howard had negative returns in fy 2014, - 5.44% and since inception 3 years ago returned 1.00% to the state pension fund.

The State of Rhode Island pension portfolio is way too complex and expensive. Warren Buffet believes that it’s too complex and so do I. There is no indication in the last 4 years that increasing costs and complexity benefit the fund. The State of Rhode Island needs to compound 7.5% for the next 25 years or so to get to proper funding levels. The chance of this occurring is less than 25%. If the Pension Reform is unwound the chance of proper funding will drop dramatically and the returns on the pension funds’ assets will need to be enormous.

Editor's note:  A previous version incorrectly stated that Brevan Howard earned $6.5 million in fees; it has been edited to reflect the correct amount of $5.13 million.  

Michael G. Riley is vice chair at Rhode Island Center for Freedom and Prosperity, and is managing member and founder of Coastal Management Group, LLC. Riley has 35 years of experience in the financial industry, having managed divisions of PaineWebber, LETCO, and TD Securities (TD Bank). He has been quoted in Barron’s, Wall Street Transcript, NY Post, and various other print media and also appeared on NBC news, Yahoo TV, and CNBC.