Kentucky’s state pension system should get out of hedge funds, lawmakers say

Kentucky’s struggling public pension systems should stop investing in hedge funds to avoid their complex, expensive fees and often lackluster returns, some lawmakers said Tuesday.

“What the hell are we doing in hedge funds?” asked state Rep. Jim Wayne, D-Louisville, during a briefing on the pension systems.

Although the legislature is not in session, Democratic members of the state House of Representatives came to the Capitol for the briefing. Members of the House Republican minority skipped the event, which their floor leader called a “charade,” because the Democrats — who were paid to travel to Frankfort on legislative business — later attended a political fundraiser in nearby Lexington.

During the briefing, legislative staff showed that the $14.9 billion Kentucky Retirement Systems has more than 10 percent of its assets invested in hedge funds, while the $16.8 billion Kentucky Teachers’ Retirement System and the $436 million Kentucky Judicial Form Retirement System both stay away from hedge funds.

Hedge funds are privately run portfolios that try to make a profit regardless of market conditions. They can include combinations of stocks, bonds, real estate, commodities and other assets.

Hedge funds on average produced a negative 5.5 percent return over the last year, a 1.8 percent return over the last five years and a 1.7 percent return over the last 10 years, according to data presented at the briefing. By contrast, U.S. stocks yielded a 7.4 percent return over the last 10 years.

Bo Craycraft, a legislative staff member who advises the Public Pension Oversight Board, said hedge funds make money from both management and performance fees that are reported differently from fund to fund. Investors sometimes have had a difficult time getting answers on how much they’re paying the funds, Craycraft said.

“If we don’t understand how the fees are calculated, then why would we invest in something?” interjected state Rep. Chris Harris, D-Forest Hills.

News stories have highlighted the poor financial condition of state employees’ pensions at KRS compared to the well-funded legislative pensions, House Speaker Greg Stumbo told lawmakers. The largest KRS fund for state employees has only 17 percent of the money it’s expected to need to cover future benefits.

Blame should be placed on unwise investments at KRS, Stumbo said. Legislative pensions are mostly invested in U.S. stocks, while KRS has squandered millions on riskier assets that failed to pay off, he said.

Stumbo waved a copy of Tuesday’s Herald-Leader and expressed his concern about a story showing how KRS is doubling down on a hedge fund — Prisma Capital Partners’ Daniel Boone Fund — that last year produced a return for the state of negative 8 percent. Some top officials at KRS previously worked at Prisma, Stumbo noted. That hedge fund now holds more than $700 million for KRS.

“There needs to be more light shone on the actions and investment strategies of this board,” said Stumbo, D-Prestonsburg. “I’m not saying anyone did anything wrong. I am saying it doesn’t look right to me.”

KRS is responsible for providing retirement benefits for more than 355,000 people who have worked for state or local governments. It is overseen by a board — recently revamped by Gov. Matt Bevin — that includes some trustees appointed by the governor and others elected by public employees.

Some public pension systems, including the state of California’s and the city of New York’s, have announced their withdrawal from hedge funds. But KRS officials consistently have defended their investment in hedge funds, telling lawmakers at past hearings that the funds offer stability when other asset classes, like stocks, are losing value.

The General Assembly has not attempted in recent years to outlaw particular pension investments. Bills to require greater accountability from the pension systems have failed.

Last winter, Republican state Sen. Chris McDaniel of Taylor Mill filed two pension transparency bills. One would have opened the pension systems’ business practices to outside scrutiny and required the same competitive bidding for investment services that is used elsewhere in state government. The other would have expanded the Kentucky Open Records Act to cover legislators’ pensions, so people could know how much their lawmakers expect to collect in retirement benefits.

After passage by the Republican-controlled Senate, both bills died in the Democratic-controlled House, as did a last-minute compromise bill.

This story was originally published August 30, 2016 at 3:58 PM with the headline "Kentucky’s state pension system should get out of hedge funds, lawmakers say."