February 14, 2012

Pensions and Hedge Funds – Ins & Outs

There’s been a lot of talk recently about pension funds being drastically underfunded. Some studies peg the funding gap for state and local pensions at more than $1 trillion. To make up the gap, pensions either have to force their members to contribute more, cut back on benefits or make it up by earning returns in the market. (Sounds like social security, doesn’t it?)

For now, it looks like pensions are turning to the market, specifically hedge funds, to boost returns despite less than stellar performance from the sector as whole. Some states, like South Carolina, are actually cutting back their hedge fund allocations. But just over the border, North Carolina’s pensions system, which is pouring billions into the alternative space, is more emblematic of the rest of the nation.

Some warn of dangers ahead if pensions try to juice their returns by taking on more risk. Others argue that even a modest allocation to hedge funds by pubic pensions could unlock $13 billion in annual returns and actually reduce risk by investing in assets that are uncorrelated to the market as a whole. It’ll be interesting to see who comes out ahead in the debate. But one thing we know for sure, pension funds are already lowering their return expectations — a sign they don’t expect huge returns from the market itself.

Further reading – Pensions Investing with Fingers Crossed and Eyes Closed via CNBC.com (Op-ed from DPR client Mebane Faber of Cambria Investment Management)

Zach Kouwe