The New Jersey Pension Fund invests with a private equity firm that owns the National Enquirer. While progressively-oriented public employees in the Garden State will be surprised to learn that their retirement contributions may be bolstering a pro-Trump tabloid, it also begs the larger question of whether pension funds should invest in risky high-expense vehicles like private equity and hedge funds, or whether de-risking their portfolios through low-fee, passive investments is a more prudent strategy.
Last October, Pensions & Investments reported that the New Jersey Pension Fund committed up to $200 million to the Chatham Asset Private Debt and Strategic Capital Fund, managed by Chatham Asset Management. Chatham owns 80 percent of American Media, Inc., parent company of the National Enquirer, which has been struggling with shrinking newsstand sales and may now come under legal pressure now that it is in the cross-hairs of prosecutors investigating the President’s scandals.
It is not clear whether any of Chatham’s interest in AMI has been shared with investors in the Private Debt and Strategic Capital Fund which does not report the details of its investment portfolio. However, we do know that this vehicle charges New Jersey 0.79 percent annually for management and administrative fees and has a concentrated position of 20-30 names, many of which are categorized as stressed or distressed.
So, New Jersey retirees are paying high fees for the hope of getting high returns if Chatham’s portfolio companies can avoid bankruptcy. The New Jersey Pension Fund is not the only system betting on such costly “alternative” investments: high assumed rates of return are pressuring many public pension system managers to take on more risk.
New Jersey Pension Funds can allocate up to 12 percent of their assets to private equity investments and 15 percent to a category called “absolute return strategies,”, which are implemented by hedge funds. Private equity and hedge fund investments are often characterized by high fees, opacity and poorly understood risks.
Funds may be better advised to invest their money in low-cost stock and bond portfolios. Even individual investors with small portfolios can take advantage of passive investment vehicles with low fees. Passive investments, like stock index funds, lower costs by tracking the market rather than trying to outperform it. Annual expense overheads of less than 0.10 percent have become quite common for index funds with Fidelity recently inaugurating two funds that charge no fees whatsoever. Newly published research finds no correlation between the external investment fees state pension funds pay and the returns they achieve.
One state that has embraced low-cost pension fund investing is North Carolina. State Treasurer Dale Folwell has been transferring assets in the North Carolina Retirement System from professionally managed funds into internally managed indexing strategies. Between January 2017 and June 2018, fees paid to investment managers were reduced by $86 million. The North Carolina system still invests in alternative products, but private equity accounts for just over 5 percent of the system’s assets.
From one perspective, the North Carolina Retirement Systems can afford to de-risk. With a funded ratio of over 90 percent, the system does not have to “swing for the fences” to remain solvent. By contrast, New Jersey’s state plans are only 56 percent funded. But rather than take on more downside risk, New Jersey could improve its funding levels by increasing employer and employee contributions and by adjusting benefits, especially for new employees.
Although passive investments lack the upside potential of high flying hedge funds and highly leveraged private equity vehicles, they are also less likely to produce unpleasant surprises. With the long-term well being of both retirees and taxpayers at stake, less dramatic portfolios that consistently meet their investment objectives would seem to be the more prudent alternative.