Pension plans should avoid hedge funds
In 2016, for an eighth consecutive year, the average hedge fund trailed the return of the benchmark S&P 500 index. That underperformance has averaged more than 5 percent each year. But that didn’t stop the top-paid hedge fund managers from raking it in, regardless of their fund’s poor performance. Last year, the 10 highest-paid hedge fund managers received annual compensation averaging about $765 million.
Why should we care if a few hedge fund managers get fabulously wealthy by seducing the rich to part with their money? If that were the only problem, then we could look elsewhere for reform. But these folks are ripping off hard-working middle-class Americans. More than half of the $3 trillion held in hedge funds nationwide is pension fund and retirement plan investments.
When the managers rake in excessive fees while their funds perform poorly, then either pension benefits will shrink or, in the case of public funds, taxes will be raised to make up the shortfall in the promised pensions.
Over the past eight years, by my estimate, pension plans have cumulatively lost about $600 billion compared with what they could have earned by passive (unmanaged) investment. That’s a lot, and that’s why I have pleaded with the Board of Directors of the San Francisco Employees’ Retirement Fund to abandon its misguided policy of investing in hedge funds.
The leader of the top-paid hedge-fund managers pack, James Simons, took home $1.6 billion in compensation. One of his public funds gained 21.5 percent to beat the S&P index return of about 12 percent, while his other public fund returned 11 percent. No. 2, Ray Dalio, took home $1.4 billion. This despite the fact that his largest fund, Pure Alpha (with assets of about $62 billion), returned 2.4 percent for 2016. The compensation to the remaining top-paid managers came from many funds that underperformed.
Shakespeare asked, what’s in a name? Well, if the name is “hedge fund manager,” the answer is a lot. Just calling oneself a “hedge fund manager” apparently magically entitles that person to compensation far above what any investment adviser or money manager earns.
Just to keep these compensation figures in perspective, the cumulative pay of these top 10 guys was about $7.6 billion, or more than the combined salaries of every professional football and basketball player in the country. This exceeded the combined compensation of the CEOs of all of the S&P 500 companies.
For the most part, hedge fund managers are able to collect this outsize compensation because they have convinced people that they possess special proprietary knowledge that will translate into higher returns. They clearly get an A+ for their ability to attract money and siphon off significant portions for their own benefit. But just as clearly they fail to provide adequate returns for their investors.
How long do hedge funds need to underperform before pension funds (both public and private) stop throwing money at them? When will hedge fund investors wake up and see that the managers’ compensation is no match to their management performance? Common sense would tell us this arrangement should have ended years ago.
But it’s easy to be drawn in when pension fund trustees are investing other people’s money. The lust for imagined riches and the desire to be part of the special fraternity who can invest with a celebrity hedge fund manager are just too much for logic to overcome.
Unless the public wakes up and tells pension fund trustees and others deciding how to invest their retirement funds that these are unsuitable investments, hedge funds will continue to be a fabulous idea for their managers and a poor investment for the investors. Leland H. Faust is the founder of CSI Capital Management, where he supervised investment of more than $1.5 billion in assets, and the author of “A Capitalist’s Lament: How Wall Street Is Fleecing You and Ruining America,” (Skyhorse Publishing).