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Sept. 1 — Hedge funds can be problematic to investors due to high fees, lack of transparency and minimal control. The man who runs hedge fund investments for many public employee retirement plans in Massachusetts says these afflictions can be cured by using managed accounts.
A number of public pension plans, including ones in California, New York and New Jersey have recently decided to reduce or even eliminate their hedge fund investments.
Among the reasons for such actions were high fees and floundering returns.
The Pension Reserves Investment Management Board, which invests the assets of public plans serving Massachusetts, and many of the state’s cities and towns, took another path.
To gain greater control over its hedge fund investments, PRIM about two years ago began switching from industry standard commingled fund arrangements to managed accounts.
That move has paid off. PRIM has increased hedge fund transparency while “reducing fees by 40 to 50 percent,” Eric Nierenberg, PRIM’s senior investment officer, told Bloomberg BNA Aug. 31.
In fact, PRIM’s “new hedge fund investments overall have been doing better than our old ones” in commingled accounts, Eric Convey, PRIM’s director of communications, told Bloomberg BNA in a Sept. 1 e-mail.
Nierenberg said that PRIM, which oversees $62 billion, now has greater oversight as to its hedge fund investments. In managed accounts, unlike commingled arrangements, these investments remain in custodial bank accounts under PRIM’s control, he said.
When assets are invested in hedge fund commingled accounts, it’s possible in certain circumstances for the fund to prohibit an investor from withdrawing its money. This could happen, for example, during a financial crisis.
This isn’t possible in a managed account, as the hedge fund can’t deny access to money in PRIM’s custodial accounts, said Nierenberg, who is also PRIM’s director of hedge funds and low volatility strategies. Although some investments may not be easily sold—and therefore be considered illiquid—an investor will still retain access to them, he said.
“If something goes wrong with a hedge fund, a manager’s trading authority in a managed account can be turned off,” Nierenberg said. This can prevent a hedge fund manager from removing assets from the fund and putting them into his or her personal accounts, he said.
This risk can occur where a hedge fund is running a Ponzi scheme, a topic that has been in news headlines recently, he said.
Even more important than control, managed accounts provide full transparency over what a hedge fund is doing with PRIM’s investments, said Nierenberg.
This enables PRIM, which has about $6 billion—or about 9 percent of its assets—in hedge funds and related investments, to “see in virtually real time” whether a hedge fund has been doing what it was hired to do.
PRIM may learn, for instance, that it needs to “fill in the gap” with other investments to account for what the hedge fund hasn’t been investing in, he said. Such transparency allows PRIM to accurately know how much risk exposure it has at any given time.
Many investors, including public plan trustees, have been concerned about the high fees charged by hedge funds, which commonly charge 2 percent in fees in addition to 20 percent of the hedge fund’s gains.
Nierenberg said that PRIM has been able to keep fees down by negotiating fee structures that are much lower than those typically charged to commingled account investors.
He said that the typical fee structure assessed in commingled arrangements may give way to something more like a 1 percent management fee and a 10 percent of gain carry. “Both the management fee and the carry are separate forms of manager compensation that can be negotiated,” he said.
In addition, Nierenberg said that PRIM has negotiated lower fees by customizing the services it gets in its managed accounts. For example, sometimes expenses that should be absorbed by the fund will get passed on to commingled account investors, he said. In managed accounts, the PRIM can negotiate the specific expenses that it will pay for, he said.
For those wondering whether PRIM’s demand for managed accounts has limited its access to the most coveted hedge funds, Convey said that PRIM has been “very pleased with the response of managers” to PRIM’s request for managed accounts.
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