Fact? or fiction.

On September 26, 2010, in Florida Retirement System - Pension Plan, by FRS Options News

Misleading headlines are becoming more fantastic with each day we edge closer to the November elections.  Candidates, their parties, and the press are in a race to see who can be as creative with the truth as possible, in hopes of swaying momentum in their favor.

We have commented on many articles fabricating the truth about the Florida Retirement System most recently the article quoting Senator Mike Bennett as saying it is “out of control”.  We know the facts tell a different story.  FRS is one of the strongest, best managed, and most well funded pension plans in the country.

Fact? or fiction.

The latest fabrications coming to the forefront are who is responsible for Florida Retirement fund loses and the evilness of hedge funds.

The wildest is the claim that Chief Financial Officer Alex Sink is responsible for losing $24 billion from the Florida retirement funds.  The release, titled Sink At The Wheel represents that Sink put FRS funds in “risky investments that cost our seniors billions and put the Government Investment Pool in grave danger” is credited to Representative Jennifer Carroll  who also is championing an absurd investment scenario” for pension funds.  The latter part of the release is apparently attempting to tie the announcement by FRS that it will double the amount of its investments in alternative investments, better known as “Hedge Funds”, and that those hedge fund investments would be “reckless and irresponsible“.  In a recent article by Eric Seidle, Seidle claims that “Florida State Pension to transfer wealth to Hedge Fund and Private Equity Billionaires“.

As Vladimir Lenin once said, “repeat a lie often enough, and it becomes the truth”.  FRS Options has received numerous requests for more information on both the claims against Sink, and the truth behind the hedge fund investments.  Let’s start with the claims that Florida Chief Financial Officer and gubernatorial candidate Alex Sink “was at the wheel” when FRS lost $24 billion dollars.

It reminds me of the old Florida political story about claims against Claude Pepper by George Smathers that helped Smathers win the office.  He “outed” Pepper as a known extrovert , his sister as a thespian , and his brother as a practicing homo sapien.  The story goes on to say that Pepper matriculated with young women in college, and practiced celibacy before marriage.  Wow, how could we possibly elect any one to office with a resume like that?

The truth, as CFO for Florida, Sink is one of three Trustees, along with the Governor and Attorney General for the State Board of Administration (the SBA).  As such, Sink, Crist, and McCollum are required by Florida Law to be the ultimate overseer of Florida’s investment funds – including FRS.  The SBA utilizes a staff of investment professionals to manage the assets under their control.  The trustees (Sink, Crist, and McCollum) do NOT manage the investments; they simply make sure the guidelines are being followed.

The total funds in the FRS retirement fund went down during the financial panic of 2008 and 2009, in total by about 25%.  The math is pretty fuzzy in the accusations, and we cannot determine how they arrived at the $24 billion number.  The best we can come up with would indicate the assets fell in value by closer to $9 billion.  Apparently that number would not be as inflammatory in the headlines.  Furthermore, drops in asset value are not really losses until and unless the assets are sold, and the loss is realized.  Never mind that FRS grossly outperformed the investment markets, and most every other State Pension fund in the country.  The truth is not pertinent.  Enough people glommed onto it to put Sink on the defensive about something that should have been celebrated, not castigated.

The second issue getting serious press without the correct due diligence is the claims of recklessness and riskiness the state is assuming by investing in “Hedge Funds”.  We thought it might be good to discuss what hedge funds are, and whether or not they are too risky for your retirement funds.

Let’s start with the term “hedge”.  According to Mirriam-Webster, a hedge is “a means of protection or defense (as against financial loss) “.  By definition, a hedge fund is an investment pool designed to mitigate the normal risks and volatility of the stock or bond markets.  Hedge funds are designed to reduce the volatility of returns.

That sounds simple, so what is all of the fuss about.  Like in most things, a few rogues ruin it for the rest.  The press about hedge funds is seldom favorable.  Either the fantastic losses of Long Term Capital, or the billions earned by the hedge fund companies, it all looks bad.  Interestingly enough, the billions made by the managers are based on a percentage of the gains they made for their investors.  Once could argue that we should want our money managers to make fantastic amounts of money, as they only make it if their investors do.

Hedge funds are limited to institutions (insurance companies, pensions, etc) and to very high net worth investors by the SEC.  The reasons are simple.  Hedge funds are not regulated like a mutual fund company is regulated.  A hedge fund manager can invest in almost anything they choose.   They can sell short, hold concentrated positions, borrow to leverage their holdings, and more importantly – do not have to be “transparent” about their holdings.  They also do not have to provide liquidity like a mutual fund does.  If you qualify to invest in a hedge fund, you are agreeing to allow the manager to manage your money, without the knowledge of what his positions are, and knowing that if the markets are performing poorly, the manager can choose not to cash you out if it would be detrimental to the other investors.

The lack of transparency and liquidity, as well as the lack of regulation make good rhetoric that hedge funds are too risky for FRS.  Is that a fair assessment?  Probably not.  Hedge funds, like mutual funds, attract investors based on their track record, as well as the investment objective of the fund.  It is highly unlikely FRS will invest in hedge funds without doing exhausting due diligence on the managers and their track records.

FRS is also only going to put up to 10% of their assets in alternative investments.  It would not matter how dismally those funds would perform, they are certainly not going to bankrupt the system.  FRS has stated that they are trying to get positive investment returns, even if the stock markets are down – as they were in 2008-09.  That seems very prudent for a pension plan to do.  The smartest minds in investing are those in charge of pension money.  They understand what they are investing in, and what impact it will have on their assets.

According to the Credit Suisse Tremont Index, the average hedge fund gained 6.6% per year for the past decade, while the Dow Jones Industrial Average and the Standard and Poor’s 500 LOST an average of about one percent per year for the same time period.  Those numbers prove that hedge fund returns are not stock market dependent, and actually “hedged” a portfolio’s market exposure.

Obviously, FRS is not transferring wealth to anyone, simply allowing a bigger part of the investment pool to be placed with hedge fund managers.  The most interesting part of the article sighted above, is that the author himself (Seidle) is a hedge fund manager, but proposes his funds are less risky since he discloses his investments.  He also makes the claim that he, the GAO and Warren Buffet agree that hedge funds are too risky.  Warren Buffet (of Berkshire Hathaway and one of the wealthiest men on earth) owns hedge funds; he just doesn’t think you should, unless you know what you are getting into.

Ultimately, hedge funds will not spell the end of your FRS assets, and could well prove to be advantageous.

It’s election season, unfortunately as we get closer to Election Day we should expect that misleading headlines will become more colorful by the day.  I suggest everyone arm themselves with facts.   FRSOptions will continue to try and separate Fact from Fiction.  We suggest everyone arm themselves with the facts, and don’t believe Chicken Little when she says the sky is falling

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  • Lt.H.Noel

    If interest rates stay at 2% any longer, FRS will have to cut benefits, require employee contributions, or join hedge funds. They cannot continue to fulfil their defined benefit obligation with the “safety” of low yielding bonds. BTW, State Street pushed its losses onto FRS in the crash of 2007-2009, not that anyone would notice, except for me.

  • http://www.floridaretirementsystem.info Mark Davy

    FRS’ investments in bonds is fairly low, 25%, and the returns on their stock
    market investments are doing well. If benefits are cut, it is a political move,
    not an investment or financially motivated reason.
    Mark A. Davy

    SouthBay Investment Group, llc
    665 S. Orange Avenue, Suite 4
    Sarasota, Florida 34236

    941-951-1977
    941-952-1937 (fax)

    ________________________________

  • Lt.H.Noel

    If 25% of FRS’s holdings is in bonds, then as much as the remaining 75% of FRS’s investments (ie: equities) took a hit through 2008-2009, and though doing well, have not “recovered”. Since corporate dividends were cut, where is FRS getting their income from to pay their obligations to retiree’s? Annuities Present Value (PV) are now costing FRS more due to low yield to maturities on their investments. Their bond holdings and dividends earned are returning less relative to their annuities cost which is eating up their retained earnings . The probability of a potential bond (and gold!) crash in Q4 2011 is very high. Giving FRS to a hedge fund now may be the only way to recover what was lost before interest rates rise, and using margin and derivitives wisely could easily gain more than what was lost, especially in this easy stock market where any savy investor can earn 30% annually (like me).

  • http://www.floridaretirementsystem.info Mark Davy

    The cash to pay retirees’ comes from a combination of new contributions from
    employers, earnings on the investment portfolio, and FRS keeps enough cash on
    hand for current obligations. Actuarially, the fund can pay out 87% of its
    expected liabilities over the NEXT 30 YEARS, which is a lot of time for the
    market to recover adequately. A bond crash (in the event it did happen) would
    only impact those bonds that FRS would choose to sell into the crash, which is
    not a likely event, and, just as the market crash allowed stock prices to be
    cheap, the same thing would happen to bonds – they could be purchased cheap at
    higher yields. To the best of my knowledge, the portfolio doesn’t hold gold.
    Hedge funds will probably be a good choice, but will only be 7% of the entire
    funds assets. All-in-all, having a relatively small shortfall for a few years
    is not a significant problem in and of itself. Keep in mind they operated with
    shortfalls all through the late 1980′s and early 1990′s. If FRS was at 50% of
    its future liabilities it would be a real concern, but at current levels, it is
    pretty much a scare tactic and fear mongering on the part of the politicians to
    take money from FRS and put it into other area’s of the budget.
    Mark A. Davy

    SouthBay Investment Group, llc
    665 S. Orange Avenue, Suite 4
    Sarasota, Florida 34236

    941-951-1977
    941-952-1937 (fax)

    ________________________________