Pension plans investing billions in riskier hedge funds


Faced with growing numbers of retirees, pension plans are pouring billions into hedge funds, the secretive and lightly regulated investment partnerships that once managed money only for wealthy individuals and elite institutions.

The plans and other large institutions are expected to invest as much as $300 billion in hedge funds by 2008, up from just $5 billion a decade ago, according to a study by the Bank of New York and Casey Quirk & Associates, a consulting firm.

Pension funds account for about 40 percent of all institutional money. This month, the investment council that oversees the New Jersey state employees pension fund said that the fund would invest $600 million in hedge funds, less than 1 percent of its assets, over the next several months.

While most pension plans have modest stakes in hedge funds, others have invested more than 20 percent of their assets. Weyerhaeuser, the paper company, has 39 percent of its pension fund's assets in hedge funds. In Congress, there has been a push for amendments that would make it easier for hedge funds to manage even more pension money, without having to comply with the federal law that governs company pensions.

Pension officials who have been shaken by market downturns and persistent deficits are attracted by hedge funds' promise of richer, or more consistent, returns. But the trend has caused some consultants and academics to voice cautions. They question whether hedge funds, with risks that are hard to measure, are appropriate for pension funds, whose sole purpose, by law, is to pay out predetermined benefits to retired workers.

Those benefits are considered so crucial that they are guaranteed: Corporate pension failures are covered by the Pension Benefit Guaranty Corp., a government agency, while pension failures by governments are covered by state and local taxpayers.

Given that the benefits are paid out on a set schedule, critics wonder whether it makes sense to rely on investments whose returns are hard to predict, managed by private partnerships that disclose little about their operations and charge some of the highest fees on Wall Street.

"It's very inappropriate when the company is offering a pension plan that is guaranteed by the federal government," said Zvi Bodie, a professor of finance and economics at Boston University who writes and lectures on sophisticated investment techniques and is enthusiastic about hedge funds in other contexts.

Hedge funds make large, sophisticated investments based on the premise that by swimming outside the currents of the markets, often betting against conventional wisdom, they can outperform other investments.

Recently, hedge funds have made headlines when they ran into trouble: Long-Term Capital Management, a hedge fund whose principals included two Nobel Prize-winning economists, nearly collapsed in 1998; and this summer, Bayou Group, a $450 million hedge fund based in Connecticut, shut down after most of its money disappeared. Its two officers have pleaded guilty to fraud charges. Hedge funds are meant to be only for wealthy, sophisticated investors so regulators have not monitored them as they have stocks or mutual funds, although there have been calls for increased regulation.

The news of splashy gains and scandals might not accurately reflect a business that in many ways has become more conservative as a result of the flood of pension fund money. To attract that money, many hedge fund managers emphasize stability.

Among pension fund managers, "the whole mentality has changed," said Jane Buchan, chief executive of Pacific Alternative Asset Management, which manages $7.5 billion in accounts that invest in hedge funds, primarily for large pension funds. "They are saying, `We need returns, and we will be aggressive about getting them.' They just don't want any downturns."

One of the first pensions to start working with hedge funds is also the nation's biggest corporate pension fund, the $90 billion General Motors fund. It started with a small test investment in 1999 and increased it to about $2 billion in 2003, said Jerry Dubrowski, a GM spokesman.

The company is using hedge funds, along with other unconventional investments, in hopes of getting something close to stock market returns without the market's volatility, Dubrowski said. To pay out the $6.5 billion GM owes to its retirees each year, the pension fund must produce annual returns of a little more than 7 percent. Otherwise, GM will have to dip into the fund's principal. At current interest rates, GM cannot get those 7 percent returns with bond investments, and if it tries to raise returns by betting on the stock market, it will have to cope with market swings.

"It's really not helpful to have that up-10, down-10" performance, Dubrowski said. "You want a return that allows you to cover the benefits payments without attacking the capital."

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