New Jersey needs a Global Investment Strategy

New Jersey is one of a few states that manage their pension funds directly.

Tom Byrne.
Tom Byrne, Chair, NJ State Investment Council. (Via YouTube video)

TRENTON, N..J., June 4, 2015 — On Wednesday the New Jersey State Senate Legislative Oversight Committee received testimony from Tom Byrne, chairman of the New Jersey State Investment Council,  regarding the state pension system and its strategies as they relate to hedge fund investments and private equity investments (non-publicly traded companies).

The State Investment Council sets policy for the pension system, which has accumulated over $80 billion in assets and generated over $7 billion of additional revenue over the last 10 years.

New Jersey is one of a few states that manage their pension funds directly. The individual pension funds—traditionally equities and investment grade bonds—are managed on a daily basis by the staff of the state’s Division of Investment.

That staff has done quite a good job in recent years. Over 4.5 percent more was made by funds in their hands, according to the June 2009-June 2014 balance sheet reports, than by private hedge funds.

A division spokesperson emphasized that the state’s equity investment portfolio has done an outstanding job. However, looking forward, the division is unsure whether that level of performance will be repeated over the next four or five years.

The division also indicated a need to incorporate a more global investment strategy, including foreign stocks, in which the state currently underinvests due to lack of expertise. “It is extremely imprudent to limit our investment strategies to domestic equities,” the spokesperson said.

The division of investments points to the genesis of the state’s alternative investment program as a response to recommendations made on the assessment of fund losses in the amount of $17 billion that occurred between 2001 and 2002. These losses were realized in the public equity markets.

Traditional investments include stocks, bonds and cash. Alternative investments, a program that commenced in 2005, includes real estate, private equities, hedge funds, commodities, infrastructure and private debt. Hedge funds are incorporated into the investment strategy for risk mitigation purposes.

Sen. Gordon, D.38, asked whether the hedge funds did that in 2008. The division response noted that the state did considerably better than its peers and much better than the overall market during that time period with regard to reducing portfolio losses.

Sen. Sario, D.36, argued that the state is short roughly $680 million of the scheduled actuarial payment associated with the pension obligations and that investment fees paid to outside investors totaled some $600 million. He concluded that those fees would be better spent closing the budget shortfall in that particular line item.

It is questionable, however, whether anyone can find an investment that can provide a return without a fee. Some portion of that money, even if allocated to this year’s pension payment, would be subject to fees.

A Treasury Department representative clarified that the the $600 million was both a flat fee of $230 million and an incentive fee of $370 million. He indicated that the fees were contingent on fund performance, meaning the state was obligated to pay more, the more revenue the fund produced.

It would have been good to see the discussion go in the direction of structuring deals that pay a percentage on every investment dollar earned and that take a discount on any monies lost outside of paying flat fees. Most large public pension funds do not fully disclose fees, as there is no standard requirement for that disclosure. Ten of the 17 largest pension funds do not disclose carried interest retained, and only two of 17 large pension funds disclose as much as New Jersey does.

For the benefit of its taxpayers, New Jersey has chosen to disclose a greater level of carried interest beginning in fiscal year 2014. In FY 2014, the alternative investment program generated $3.1 billion in in net profits and realized a net return of 15.2 percent.

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