Land of Enchantment apparently disenchanted with hedge funds

Institutional investors seem have developed a love/hate relationship with hedge funds according to a report published by SEI last week.  Says the firm…

“..the SEI analysis details growing institutional acceptance of hedge fund investing. Forty-seven percent of the institutions surveyed said they already invest in hedge funds. Within that group, 73% of pension plans and 55% of institutions overall said they had increased hedge fund allocations over the last several years. Portfolio allocations to hedge funds averaged 30% for endowments, 13% for pension funds, and 24% for institutions.”

However, the firm also says that institutions remain nervous about their hedge fund investments:

“At the same time, institutions expressed continued concerns with hedge fund investing. “Headline risk” was named by 37% of survey respondents as their biggest worry, followed by lack of transparency (19%) and poor performance (15%). Institutions also remain cautious in selecting hedge funds, the survey found, devoting an average of seven months to due diligence and 12 additional weeks to approval.”

Politicians are – quite rightly – sensitive to “headline risk”.  One such politician is New Mexico’s Teresa Zanetti.  She tabled a bill in the state legislature at the end of January that would ban hedge fund investment by the $15 billion New Mexico State Investment Council (although, according to Pensions & Investments, it would have allowed the State pension plans to continue investing in hedge funds).

Zanetti couldn’t get the bill to the legislature by a deadline last Thursday and will now have to reintroduce it next year.  According to new reports, next year’s version will include the two state pensions, for a total of approximately $40 billion of State controlled assets.

According to New Mexico Business Weekly, Zanetti says:

“A lot of people hitch their wagons to hedge funds to improve returns, but these can be very risky investments…We saw that last summer with the mortgage meltdown. The SIC [State Investment Council] wants to expand its investments in hedge funds, but I think that is essentially gambling with the public’s money.”

The head of the State Investment Council isn’t so sure though.  He tells the publication:

“The biggest risk the portfolio has is not from hedge funds, it’s from the stock market, which has taken a dive…We need to protect against that, and that’s exactly what hedge-fund investments are all about.”

We tend to side with the State Investment Council (SIC) on this one.  That’s exactly what hedge fund investments are all about.  They’re all about alpha.

According to P&I, the SIC is also concerned about the extremely broad definition of “hedge fund” in the bill.  Here is the actual bill.  What do you think?  The excerpt below shows the proposed amendments (in bold):

“B. The state investment officer shall formulate and recommend to the council for approval investment regulations or resolutions pertaining to the kind or nature of investments and limitations, conditions and restrictions upon the methods, practices or procedures for investment, reinvestment, purchase, sale or exchange transactions that should govern the activities of the investment office; provided, however, that the state investment officer shall not recommend and the council shall not approve investment in a hedge fund. As used in this subsection, “hedge fund” means a private investment fund or pool, including a relative value fund, market neutral fund, arbitrage fund or long or short equity fund, the assets of which are managed by a professional management firm that:

  • (1) trades or invests, through public market or private transactions, in securities, commodities, currency, derivatives or similar classes of financial assets; or
  • (2) is not an investment company pursuant to the provisions of 15 U.S.C. 80a-3(c)(1) or 15 U.S.C. 80a-3(c)(7).

If you boil down the changes, you get:

“…’hedge fund’ means a private investment fund or pool…the assets of which are managed by a professional management firm that trades…in securities…or is not an investment company.”

We can certainly see the SIC’s concern that this can be interpreted to include private equity as well as hedge funds.  (But what is a “private investment pool”?…)

If the New Mexico Business Weekly is reflective of the general opinion about hedge funds in the state, then Zanetti is certainly making the right political choice.  Says the publication (emphasis added):

“Hedge funds are currently en vogue thanks to the high, and sometimes phenomenal, returns they can offer. Unlike mutual funds, which only invest in stocks and bonds, hedge funds invest in everything from currencies and commodities to mortgage loans and private equity. They are generally unregulated, allowing them to make highly speculative investments, often with a huge amount of borrowed money. That can lead to extremely high returns, but also huge losses, such as the battering that many hedge funds faced during the mortgage crunch last summer.”

While the dispersion of fund returns is higher for hedge funds than for long-only funds, the industry as a whole has been a lot less volatile than equities over the past decade (take January for example).

Banning hedge funds IS a political solution to an investment problem.  Fear-mongering about a “battering” aside, the question that the New Mexico legislature will face next year is whether they prefer the systematic risk of the market or the idiosyncratic risk of a particular fund or strategy.  Recent months have shown that the idiosyncratic risk – although it could produce “headline risk” for politicians – could actually be the safer bet for the people of New Mexico.

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3 Comments

  1. Brian
    February 21, 2008 at 10:09 pm

    There was a great article about a year and a half ago (can’t find a non-locked version) about what the CIO had been doing in New Mexico.


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