Magaziner announces plan to strengthen pension fund, wants to reduce hedge fund investments

R.I. TREASURER Seth Magaziner will present a new  investment strategy to the state Investment Commission for consideration and approval; he wants to reduce the state's investment in hedge funds to strengthen the pension fund.  / PBN FILE PHOTO/ MICHAEL SALERNO
R.I. TREASURER Seth Magaziner will present a new investment strategy to the state Investment Commission for consideration and approval; he wants to reduce the state's investment in hedge funds to strengthen the pension fund. / PBN FILE PHOTO/ MICHAEL SALERNO

(Updated 11:51 a.m.)
PROVIDENCE – Faced with high fees and poor performance, Rhode Island’s general treasurer plans to reduce the state’s investment in hedge funds, walking back a strategy implemented during the Great Recession.
General Treasurer Seth Magaziner on Wednesday proposed the new strategy, dubbed “Back to Basics,” to the R.I. State investment Commission, which oversees the state’s $7.6 billion public pension fund. The commission unanimously approved the plan Wednesday morning.

The new strategy, among other things, calls for a $500 million reduction from the fund’s allocation in hedge funds, which previously totaled about 15 percent of the overall portfolio.
“The new strategy is expected to improve performance and reduce risk,” Magaziner said during a Tuesday meeting with reporters.
The shift in approach comes after several months of portfolio review. The $500 million reduction would decrease the state’s total investment into hedge funds to about 6.5 percent, which is still higher than the national average. But Magaziner says the new allocation will be a more responsible fiscal approach to an asset class that’s been a drag on the pension fund.
Gov. Gina M. Raimondo, the state’s former general treasurer and Magaziner’s predecessor, first established the new hedge fund portfolio in 2011 to protect Rhode Island from future recessions. Previously, the fund was primary invested in the equity market, which proved detrimental when the market crashed in 2008 and the fund realized a 31 percent reduction within one year. The drop also marred the state’s 80 percent funded ratio, a calculation of pension assets to liabilities, which fell below 50 percent, threatening the fiscal well-being of state employees’ and retirees’ pensions.
Hedge funds, however, which are supposed to hedge against market volatility and provide a smooth return over time, have underperformed in the last five years and cost a lot in fees, according to Magaziner.
“Some of our hedge funds have performed very well … most have not,” Magaziner said. “That protection against volatility, some of the funds have provided, but a lot of them haven’t done it the way they were advertised to do so.”
In the last three years, hedge funds in Rhode Island realized a greater than 6 percent return, but the state paid more than half of that in fees.
“There’s something that’s broken here with the fee structure,” Magaziner said. “It’s one thing if you’re talking about private equity and there are high fees, but there are also high returns that are being generated and the majority of the value is being returned.”
Private equity, one of the state’s highest performing asset classes, will partly reap the benefit of Magaziner’s reallocation, as he’s proposing to increase the state’s current investment of 7 percent to 12 percent. At the same time, the general treasurer is proposing to increase the fund’s income allocation from 3 percent to 6 percent. The plan also restructures the state’s low-risk allocations in an attempt to protect against inflation and economic crisis.
“The new portfolio we’re moving to outperforms the existing one under almost every scenario that we could think of,” Magaziner said.
Moving forward, the state will determine whether to change its assumed rate of return. Rhode Island – like most states – has struggled reach its assumed rate of return of 7.5 percent each year. The risk with lowering the assumed rate of return, however, might be more political than anything else, as it would increase the state’s unfunded pension liabilities, worsen its funded ratio and result in the state having to contribute more money each year toward the fund.
Magaziner, who says he’s had positive discussions with state leadership about these changes, says it’s too early to predict what the new rate should be. But he expects to reach a decision by next spring and believes the new rate should be based on realistic assumptions.
“If we use unrealistic assumptions, it’s only going to hurt us in the long run,” he said.

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