A federal auditor stated that while more and more companies are investing pensions into hedge funds, many pension fund trustees and administrators do not fully understand the nature of hedge funds or the true risk involved.
An Unpredictable Market
More and more companies are switching pension plans to defined contribution pensions, which rise and fall with the market that the money is invested in. U.S.
State and local governments are relying heavily on the returns from these investments to pay their employees benefits, but the unpredictable market has recently made the value of these returns fall.
Coupled with budget cuts that results in less and less available money to be invested in the funds, the U.S. is becoming alarmed about a pension funding shortage.
To keep up with the demand for benefits, companies have been investing their pension funds’ dollars into hedge funds and private equity, as they pay higher returns.
But the higher returns come with a higher risk. Barbara Bovbjer, the Government Accountability Office’s managing director, testified to the Labor Department’s pension council on the risk of hedge-fund-heavy pension schemes.
The High-risk Answer
She said that while these hedge funds “offer plan sponsors advantages that may not be as readily available for more traditional investment options,” they also require a more sophisticated skill set on the part of the fund’s manager. “Investments in such assets place demands on plan sponsors that are significantly beyond the demands of more traditional asset classes.”
The latest figures show that large corporate pension plans with investments in hedge funds has shot up in the last 9 years, from 11% in 2001, to 60% in 2010. The “demands” that hedge funds place on fund managers are considerable. Plan sponsors must be careful in their hedge fund selection, and Bovbjer said that most are investing in only top-performing private equity funds.
They also do much more research and monitoring of their hedge funds to counteract the higher risk involved. Bovbjer still said, however, that “according to plan officials, regulators, and others, some pension plans — especially smaller plans — may find it particularly difficult to address the various demands of hedge fund investing.”