Back in the heady days of 2009, when America was beginning to come to terms with the financial crisis and the dark mathematics used by some of the finance world’s most lucrative practitioners, the New York Times published an article entitled “Public Pension Managers Rethink Hedge Fund Ties.”
The article discussed the losses that had damaged many American pension funds, and detailed the reactions to them. Many in the pension management world were leaving the hedge fund world behind. It was too unstable, and too prone to large losses. That was probably an unfair assessment. In the meltdown it was nigh impossible to find an escape route unfurnished with loss.
One of the most prominent hedge fund investors in the pension world, the New Jersey state employee fund, had $4 billion invested in funds and by April of 2009 lost $800 million. The state stopped all investment in of pension monies in hedge funds in the early months of 2009.
The reactionary flight from hedge funds is over. Despite the worst year ever for the investment vehicles in 2011 they have come more and more into the mainstream of the investment world across the globe. Pension funds, battered in recent years and looking desperately for a vehicle to help them meet their targets, have now come back into the fold.
This brings us directly to Och-Ziff Capital Management Group LLC (NYSE:OZM). In a recent report RBC Capital Markets detailed the growth that Och-Ziff Capital Management Group LLC (NYSE:OZM) is likely to achieve through the release of more and more pension funds into its care, increasing its management fees.
The analysts seem quite convinced of this thesis, giving the firm a price target of $10. The firm is currently trading at just over $8. Part of the new allocation the report projects is heading to Och-Ziff Capital Management Group LLC (NYSE:OZM) coming is from New Jersey.
State laws mean a maximum of 15% of the assets can be placed under management at hedge funds. New Jersey is seeking to increase its current allocation to 12.5%. The state currently invests around 9% of pension assets in hedge funds.
Matters are more extreme in Florida. The State Legislature has passed a law that will see the limit on alternative and hedge fund allocations increase from 10% to 20%. The pension fund managers are unlikely to reach the upper limit but they will almost certainly direct a large chunk of their assets into hedge funds.
Hedge funds are a useful and successful financial tool, but they deal in innumerable complexities. The funds are not allowed to advertise to the general public, but the investment of large chunks of pension money into their accounts means they are de facto investing for the general public, a public with little understanding of the workings of such funds.
That is not bad in and of itself. The problem lies in the motivation for increased investment into hedge funds by pension managers. Pensions are behind in their targets as America’s Baby Boomers start to retire. From now on entitlement will swell while payments into funds shrink. States are worried about being unable to meet their obligations. It is in this reactionary atmosphere that they flock to hedge funds to solve their problems.
Solve them they might, but the funds will take their share in management fees, and, if successful, another chunk in performance bonuses. If they do not solve them, pension funds are left out in the cold, further away from their targets.
The problem is that hedge funds are expected to outperform the market, as they promise. Many now promise returns no matter what market conditions prevail. Pension managers expect the increases from the fraction of their funds invested in alternative investments to balance out the lower return in safer sectors.
Because of their massive diversification in the name of safety, pension funds are unlikely to outperform the market in any meaningful or general way. They are much more likely to stay in line with the market as they invest throughout it.
According to the RBC report, this situation is likely to continue and is likely to continue balooning. Funding deficits among funds are increasing, and the likelihood of slower economic growth in the coming years will push managers toward alternate investments.
This is, all in all, good news for hedge funds comfortable in dealing with pensions, Och-Ziff Capital Management Group LLC (NYSE:OZM) is clearly at the forefront here, attracting money from several states, and expecting to attract more. Those funds will perform well as their management fees increase.
The fate of the funds under management will be difficult to predict. It will depend on each individual state and the mix of funds they have invested with. As is always the case, some will lose and some will gain, it is likely there will be little in the way of a close in funding deficits in a general case, though there may be in individual ones.
Pension funds are probably the most important investment in the market because they represent a bigger slice of the population than anything else in the country. Their management remains a mystery to many shareholders. That is a worrying trend.