One of the mildly surprising things about the Stuyvesant Town debacle is the kinds of investors the deal attracted. What were entities like CalPers and the Church of England doing plowing their money in along with real estate moguls like Tishman Speyer?
The answer is “looking for alpha”. Underfunded pension funds have been
looking for extra return in order to make up the holes . . . and the
problem is worst among public pension funds, because until recently,
their accounting wasn’t very good, so politicians were fond of making
unfunded promises in lieu of wages.
Needless to say, public
pension funds cannot necessarily afford to attract top investment
talent, particularly since appointments tend to have a political as well
as financial component. They’re thus vulnerable to making investments
that aren’t in their best interest–not just in real estate, but in
things like derivatives, as Felix Salmon notes:
In
reality, it’s not the pension funds which are engaging in
“derivatives abuse”, but rather the investment bankers who sell the
pension funds complex over-the-counter derivatives which make the
broker lots of money and which rarely do any good for the end client.
As Clavell says,Let’s assume you work at a
Pennsylvania school board, or
a Swiss private bank, an Australian life insurance company, a German
corporate treasury, a UK Pension administrator or any one of thousands
of other buyside entities, supposedly with sufficient expertise that an
investment bank can classify you as a non-retail customer.The more complex the structured product, the more opportunity for
agents to extract fees at your expense…Admitting you don’t know is pure alpha; you will not claim to have
any edge and this may put you off involvement in the product. If you
claim you do know where the fees are, banks want you as a customer. You
don’t know. Really, you don’t. Hang on, I hear you shouting that you’re
actually smarter than that, so you do know. Read carefully: Listen.
Buster. You. Don’t. Know.
The fees are hardly the worst part; more worrying is that many public
pension funds and other public trusts are assuming risks they don’t
necessarily understand. They think they’re gaining alpha–higher
expected value on their investments. But often they’re confusing alpha
with beta, which is to say they’re getting higher returns not because
they’re making good investments, but because they’re taking on more
risks.
I don’t think I need to convince many people that
high-risk, high-return investments are a bad way for public pensions to
try to deal with their massive unfunded liabilities.
Felix is
right that the investment bankers who push these sorts of things on
public pension funds are, at the very least, doing something unsavory.
But they don’t deserve all the blame. Public pension funds shouldn’t be
trying to make up their deficiencies by chasing unrealistically high
returns. Of course, if politicians and their appointees had the courage
to pay for the gifts they gave public employees, rather than looking
for loopholes, we wouldn’t be in this mess in the first place.
