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Skarbeck: Pension funds rethinking zeal for hedge fund bets

August 9, 2014

Ken SkarbeckThe California Public Employees’ Retirement System, the largest public pension fund in the United States, recently announced it would reduce its hedge fund investments by a dramatic 40 percent.

In prior columns, I have been critical of the overall poor performance of the hedge fund industry and the excessive fees raked in by underperforming funds. Over the past five years, the HFRI Fund Weighted Composite Index (a common hedge fund index) has returned 6.5 percent annually. Conversely, the S&P 500 index (a broad measure of stock market performance) has trounced hedge funds by averaging 16.4 percent annually.

Unbelievably, most hedge funds have been unable to achieve the assumed rates of return that pension funds require to remain financially sound. The exorbitant fees collected by underperforming hedge funds have basically served to pull wealth from the pockets of retirees and taxpayers and instead fund the lifestyle of hedge fund managers. Clearly, this wasn’t the result pension plans were expecting when a decade ago they piled into hedge funds.

Now, it appears that more than a few institutions are questioning their hedge fund commitments. The Los Angeles fire and police pension fund got out of hedge funds altogether last year after earning less than a 2 percent return over seven years. Officials noted the hedge fund allocation was just 4 percent of their total portfolio, yet amounted to 17 percent of the pension’s total fees. Pension plans in Ohio and New Jersey have begun to reduce hedge fund allocations. Others are likely to follow.

Citigroup judge rebuffed

Let’s update another story I previously wrote about, the Securities and Exchange Commission’s 2011 civil fraud suit against Citigroup. The case, which accused the bank of duping investors into buying complex mortgage securities, has come to a conclusion.

Originally, Citigroup and the SEC had reached a 2011 settlement resulting in a $285 million fine, but that was rejected by outspoken Manhattan Judge Jed Rakoff.

Rakoff has been a vocal critic of the settlements regulators and the banks have agreed to as punishment for the behavior of Wall Street during the credit crisis. Rakoff threw out the deal saying the fine amounted to “pocket change” for the bank.

So the case was sent to the U.S. Court of Appeals, which last week ruled that Rakoff had “abused” his discretion in denying the settlement between the bank and the SEC. Reluctantly, Rakoff approved the deal, saying the appellate court “has now fixed the menu, leaving this court with nothing but sour grapes.”

Rakoff was one of the first judges to challenge the SEC’s long-standing practice of allowing companies to neither “admit nor deny wrongdoing” when reaching fraud settlements. The notion that firms might have to admit guilt in settlement agreements has set off widespread alarm on Wall Street. Financial lobbyists have pressured regulators against doing so, under a fear that numerous shareholder lawsuits would clog the courts.

Rakoff’s persistence seems to have inspired other judges, who in more recent cases have begun to raise questions about the perceived leniency of SEC settlements.•

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Skarbeck is managing partner of Indianapolis-based Aldebaran Capital LLC, a money-management firm. His column appears every other week. Views expressed are his own. He can be reached at 818-7827 or ken@aldebarancapital.com.

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