Saturday, February 21, 2009

A Look At One Of The World's Largest Fund Of Funds - New York State

In the wake of the Madoff scandal, it is only a matter of time before the Fund of Funds industry disappears, as investor anger grows at the glaring failure of Fund of Funds' primary responsibility - due diligence. Fund of Funds are currently perceived as worthless middle men between hedge funds and investors, pocketing 1% management fees and 10% incentive fees for arguably doing no work whatsoever. So as the investment industry contracts and Fund of Funds do all they can to stay around for a few more quarters, it makes sense to take a look at some entities that few have considered: the state pension and retirement funds. Notable among these are the California Public Employees Retirement System (Calpers), The Teachers Retirement System of Texas (TRS), the Orgeon Public Employees Retirement System and the granddaddy of them all: The New York State Common Retirement System and the New York State Teachers Retirement System. Which brings us to an interest point. As the financial system collapses and states' budget deficits skyrocket, the lives of citizens are about to get very ugly as legislators' only options are to cut state employees (i.e. police officers, healthcare workers and educators) and raise taxes through the roof. One need look no further than California which is on the brink of collapse, as absent federal assistance, it will be unable to fund its $42 billion state deficit. New York is in no better position, and David Paterson has had numerous media appearances attempting to warn New Yorkers just how difficult lives in the state are about to become. In the meantime, public workers, current and retired, of troubled states will shortly begin receiving very disturbing news, as their pensions and benefit packages are about to be drastically reduced if not eliminated altogether. The culprit? The falling market.

New York State Retirement System

At the market's peak a little over a year ago, the two principal funds that New York uses to invest retirement money, the New York State Common Retirement System and the New York State Teachers' Retirement System, had equity assets valued at over $120 billion. Since then the value of assets in these funds has plummeted and is currently at a little under $60 billion, a 50% decrease! This, unfortunately, is the pattern with all other state retirement funds, which have suffered comparable losses over the past year. The top 20 stock positions of the two New York State pension funds are listed below (holdings are presented on a combined basis). And if the drubbing of financial stocks continues, it is very likely that the value of these top holdings, which have traditionally accounted for about a third of the total funds' values, will likely continue dropping, due to the prominent positions held in both JP Morgan and Wells Fargo.

However, direct investing in stocks does not make the pension funds "Fund of Funds" per se: at most it makes them bad mutual fund-type stockpickers. And state pensioners will have ample opportunity to voice their displeasure with the performance of the funds' Chief Investment Officers, Robert Arnold for the Common Retirement Fund and George Philip for the Teachers Retirement Fund.

What is more curious is an often missed page in the Office Of The State Comptroller's website (link here) in which the New York State Common Retirement Fund discloses its monthly indirect investment in other asset managers, be they private, public equity or real estate focused. Compiling the publicly available data from February 2007 yields some curious results. Turns out in 2007 the New York Common Fund invested over $5.9 billion directly into a plethora of other hedge and private equity funds, and a total of $7.3 billion net invested over the past 2 years. Some curious names that stand out:
  • Guggenheim, which received $100 million in May 2007 and a total of $500 million, and which has since shuttered;
  • Bear Stearns, which received $20 million in June 2007, after the blow up, only to see a the entire investment (including previous installments) of $490 redeemed in August, likely at a great loss;
  • The investment of $415 million in 24 assorted office properties in October 2007 (peak of the commercial real estate market) through a JV with Liberty Washington;
  • Apollo's latest Investment Fund (VII), which received $350 million in August 2007, which somehow closed in late January with $15 billion in total commitments. Looks like New York ignored the stellar performance of the prior fund, in which most leveraged buyouts are currently bankrupt or on the verge;
  • BlackStone Real Estate Partners VI, in which the fund invested $800 million, and which closed in March 2008 with total commitments of $10.9 billion. Blackstone Real Estate became famous for its bidding war for the Equity Office Properties REIT which it won at the peak of the market with a final purchase price of $39 billion, and in which it invested almost $4 billion in equity, only to flip most of it to pay down the associated debt; they are likely stuck with the balance at a significantly underwater valuation.
  • Harbinger Capital Partners, which received a $71 million investment from the fund in 2007, and which is likely worth roughly 60 cents on the dollar;
  • Cerberus, which received $50 million in May 2007, and which might very well have been immediately funneled into such sterling investments as Chrysler and Aozora bank;
  • GoldenTree, which received $35 million in 2007, and is now running dutch auctions to offload all its illiquid holdings;
  • Xerion, which received $13 million in 2008, months after it was acquired by Perella Weinberg. As we have written, Joe Perella is probably the most important financial advisor in the country currently, advising the FDIC on its assorted activities (with very little information on how the process is compensated). If New York is invested in a fund which is run by a firm compensated by the FDIC, the potential conflict of interest here, absent further disclosure, could have massive proportions.

This is not to say that The Common Fund has only had horrendous indirect investments. In 2007 the Fund also invested $5 million in Paulson's Fund (followed by $48 million in 2008), $150 million in Chelsea Clinton's former employer Avenue Capital, and $12 million in Izzy Englander's Millennium Partners, which seem to believe in generating CD type returns with no down month as far as one can remember. The full list of fund recipients is presented here as per the data on the New York State Comptroller's page.

A Little Too Much Affirmative Action?

Following the Spitzer fiasco, and David Paterson's appointment as New York Governor, there was a marked shift in the investment targets of the Common Fund. Beginning in March of 2008, the biggest recipient of funding, by a very wide margin, were funds that are defined in the Monthly Transaction Reports as "minority-owned firms." In fact, David seems to be such a supporter of minority-led hedge funds, that in 2008 more than half of the $1.4 billion invested in assorted asset managers went to minority-owned companies, $760 million to be exact. Which implies that the only way to get startup funding these days, with traditional avenues closed, may be to apply to the New York Common Fund and check the non-white box.

The Upcoming Pension Mess

Pension funds' calculations for actuarial purposes presume a roughly 8% annual growth in perpetuity, the result of which funnel through into the over- or under-funding estimates for a State's budget for any given period of time. The current dislocation implies that absent an approximately $50 billion injection of new capital, New York's Pension Funds are guaranteed to be unable to keep up with increasing cash outflow requirements. As we mentioned, New York is not alone in this predicament, with all major public employee reitrement funds currently down anywhere between 40% and 50%. While public anger is still focused merely on the huge deficit in the state's income statement, soon all hell will break loose when millions of current police, healthcare and educational retirees realize they will have go back to work as their pensions disappear. The speed of the market's collapse will determine how quickly that day comes.

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Max Leverage said...

It seems like the entire planet went "all in" on the stock market.

Part of the problem is, fund managers are constantly receiving more funds to invest. They have no choice but to put them somewhere. If there is a global asset bubble, they're getting very little value for the money.

Another part of the problem is, the funds that get put in have to get taken out eventually. If there is any kind of demographic bubble (a big chunk of the population born between 1945 and 1955) putting money in all at the same time, they're going to take it all out at the same time too.

Makes me want to start an all-Put hedge fund. Or pull out of the market entirely and head for the hills.

Great blog, by the way.

Anonymous said...

Definitely not the right time for public employees to retire. Thanks for the excellent post.

Anonymous said...

Great analysis!


Anonymous said...

I've been wondering how pensioners will respond when they start getting IOUs in the mail? Will their outrage pour into the streets?

Can you imagine a situation where current police officers are faced with arresting thier retired seniors? I can't. I also smell another bailout.

Anonymous said...

some decent points, but one big error - Blackstone isn't invested in Stuy Town, it's BlackRock. doesn't mean NYSters or another pension fund isn't in the money there, but you should at least get the correct fund.

but overall, you hit a really good point. Ultimately, the pension funds have the most money invested in the system (through equities, bonds, private equity, RE, etc.), and could be considered to blame for much of the current crisis in so much as they were buying a lot of things they shouldn't have.

Tyler Durden said...

good point. i have too much of a morbid fascination with Stu Town. BlackSTONE did get a big slap on the wrist with EOP. curious what they carry the buildings they didnt flip for.

Anonymous said...

actually, I believe the EOP transaction worked out ok for them. by my calculations, they sold $30 billion (of the $39) and essentially got the remaining portfolio for around $4 billion. Depending on sales timing and cash flows, that should still get them a low-teens IRR. Gray was incredibly focused on flipping out of as many properties as possible so as to avoid a RJR Nabisco-type "win". It won't be a home run deal, but I think they will get out ok.

hilton may be another story...

Tyler Durden said...

been meaning to focus on that particular death watch. when hilton keels over, ladbrokes will be with out the lad and the s

Anonymous said...

what is the ladbrokes connection to hilton?

Thoth said...

just rechecked the EOP sales, and I had missed the proceeds from Maguire in LA. So total proceeds of approximately $33 billion, leaving $6 billion of the initial $39 billion. Total equity was roughly $4.2 billion, and I am assuming they paid that down somewhat from the flips. So let's say they have $2-$3 billion of equity remaining in the deal, and a portfolio that was worth $9-$10 billion at peak values. Even assuming a 50% decline in property values (probably fair, since they bought at a 4.9% cap, and market is likely 8-9% today), they are still in it at a reasonable basis.

Tyler Durden said...

you bring up and represent a valid point, namely the lowest common denominator of readers Zero Hedge has to cater to sometimes.