State Treasurer Denise L. Nappier said she plans to approve rule changes by January allowing her to allocate up to 8 percent of the state’s $20 billion pension fund in nontraditional investments such as hedge funds.
The move marks a departure from a more conservative investment strategy and comes shortly after the Connecticut funds lost nearly $5 billion in pension assets in the depressed market.
The shift in approach also comes when the hedge fund industry is under stress. The sector’s total assets declined by more than 20 percent between June and October, and the unraveling of Bernard Madoff’s $50 billion Ponzi scheme this month has spotlighted what many see as a general lack of transparency in the industry.
Still, Nappier said investing in hedge funds and other alternative instruments will allow the pension plan to reduce volatility, produce slightly higher returns and create better diversification.
“This was not a knee-jerk reaction,” Nappier said in an interview. “We are not trying to recapture losses that have occurred in the last few months. Our foray into hedge funds is a long-term and strategic plan to position the pension fund for the future.”
Hedge funds are lightly regulated pools of capital that cater to wealthy individuals and institutional investors.
They often limit information about their strategies and performance, a trait that raises risks for investors, the General Accountability Office and others have concluded.
“That makes it very tough for a potential investor to exercise their fiduciary responsibility,” said Rodger Metzger, chief investment officer of Hooker & Holcombe, an employee benefits consulting firm in West Hartford.
Attorney General Richard Blumenthal has criticized the hedge fund industry’s lack of transparency and has called for tighter regulation.
He declined to comment for this story.
The GAO citied several other risks to hedge fund investors.
Use Of Leverage
They have limited liquidity and often require an initial “lockup” period of a year or more, during which an investor cannot make withdrawals.
“That makes it difficult if you want to get out right away to minimize losses due to unforeseen circumstances,” Metzger said.
Hedge fund managers also charge higher fees and often use borrowed money to leverage client investments. That strategy amplifies potential gains or losses, Metzger said.
But Nappier said she will require more than adequate transparency and exercise rigorous due diligence. “We will not accept a don’t-look-behind-the-curtains approach to our investments,” she said.
‘Much Needed Change’
The Connecticut funds have traditionally held a conservative portfolio, investing mostly in equities and fixed income securities.
But Nappier and the Treasury’s investment advisory council have been considering nontraditional holdings since 2006.
The state hired an alternative investment consultant last year but could not take action until the pension plan’s investment policy was amended. Earlier this month, the advisory board cleared Nappier’s plan to diversify, and that process is expected to be completed by the end of January.
After that, Nappier said she will begin discussions with hedge fund managers and consider other nontraditional investments, including commodities, distressed securities and debt/equity strategies.
“It’s a much needed change,” Nappier said, adding that recent fund losses didn’t drive the decision.
The three pension funds for state employees and teachers lost 19.5 percent of their value between July 1 and the end of October, leaving about $20.7 billion.
Meanwhile, the pension plans’ liabilities are expected to increase in the coming years.
Nine States Invest In Hedge Funds
Hedge funds have been popular investment vehicles for some pension plans recently because they have often produced better results than the stock market.
According to the GAO, up to 27 percent of mid- to large- sized pension plans invest in hedge funds, including at least nine state plans.
In 2004, the Massachusetts state pension fund allocated $1.6 billion in five hedge-fund related vehicles, according to published reports.
It has achieved strong results each year since: total assets of the Massachusetts fund stood at $53.7 billion at the end of 2007, more than double the $25.9 billion it held at the end of 2002.
Nappier said states that invest in hedge funds have produced above-market results and continue to perform “better than us.”
Funds May Go Under
However, the hedge fund sector has been hit hard by the current financial crisis.
Total worldwide hedge fund assets have shrunk to about $1.55 trillion, a 20.5 percent decline from their peak in June, according to Eurekahedge, an international hedge fund research company and consultancy with offices in New York City.
Some analysts have predicted that as many as 30 percent of hedge funds could go out of business by the end of 2009.
“We’ve seen a lot of weak hedge fund managers go under,” Nappier conceded. “But this may be the best time to invest in them because we can cherry pick and deal with the cream of the crop.”
