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News & Press: Pension

Failing to contribute to N.J.'s pensions is the problem, not investments

Wednesday, May 4, 2016   (0 Comments)
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NJ.com 05/04/16

Presumptive gubernatorial candidate Phil Murphy this week criticized the fees paid for alternative investments that have both diversified and enhanced the returns of the state pension fund. He suggests lowering investment fees by concentrating more heavily in "traditional investments — such as ordinary stocks, bonds and index funds." By reducing or eliminating many of our most profitable investments, Murphy's plan would further weaken a pension system that has already been badly damaged by politicians. A candidate who is serious about fixing the pension system would focus on how he would assure billions in necessary contributions in a responsible manner. The one thing that Govs. Jon Corzine and Chris Christie agreed upon was the need to diversify the pension investments beyond stocks and bonds, and into instruments that could increase the overall investment performance of the fund, while reducing the funds' risk profile.

The state pension system has netted about $3 billion more than it would otherwise have due to the performance of alternative investments such as private equity, real estate, and hedge funds. That figure is over five years to December, and after all fees. In that time, the state has averaged returns of 15.9 percent in private equity, and 12.8 percent in real estate.These markets are less efficient than public markets, and allow investors to be active participants in growing investments. Moreover, in many cases we pay no profit-sharing fees unless and until the manager in question has returned 8 percent to us. Yes, we do pay management fees for alternative investments that averaged 1.2 percent last year. The other major alternative category is hedge funds. Our average return on them over the past five years was 5.2 percent. These funds have lagged domestic stocks in the past five years. But earlier in the decade, their results were far better than stocks.  No one category wins every year, and that is why we diversify. If Murphy wants to cut alternative investments, the choices are stocks, bonds and cash. Bonds offer almost no return today. Ditto cash. And despite the fact that stocks have had a great seven year run, they have still lagged hedge funds in 12 of the past 25 years. 

Over time frames as long as 90 years, you will see that there are many long periods in which stocks lag other investments. In fact, stocks lose money over an entire decade about 5 percent of the time. This has been an extraordinary run for stocks, and it would seem unwise to double down in betting the well-being of pensioners primarily on stocks. Doing so would fly in the face of the highly successful investment strategies pursued by our nation's top universities and sovereign wealth funds around the world. They understand that you get what you pay for. Of course, not every stock is a winner, nor is every hedge fund. The state's internal investment managers regularly review hedge fund performance, negotiate below-market fees, and cut the few managers who are not delivering our money's worth. 

Murphy says that "over the past five years, alternative investments simply have not generated sufficient returns to justify their prohibitive costs." Really? It's no surprise that he cited no numbers. They are readily available on the Division of Investment website for anyone who actually wants facts. Polling data no doubt shows that attacking Wall Street fees is good politics. We don't invest in alternatives because we enjoy criticism; we do so after hours of review internally and with outside experts to optimize expected returns. The labor representatives on the State Investment Council get it; five voted for the asset allocation plan and two abstained. It is widely agreed that the problems in the pension system stem from the state's failure to contribute, rather than due to investment returns, which even Murphy concedes are "acceptable". The gubernatorial candidates would do well to say how they would assure proper funding in an affordable manner rather than join the demagoguery on fees. 

 


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