Raimondo, as chair of the State Investment Commission, won unanimous approval in June 2011 of a new allocation strategy for the pension fund’s $7.7 billion in assets that added hedge funds to the portfolio for the first time. As of June 30, 13.9% of Rhode Island’s pension assets were invested in hedge funds.
By comparison, the median state pension plan in the U.S. allocates just 1.4% of its assets to hedge funds, according to a February study of 134 state retirement systems by Wilshire Associates, a Santa Monica-based investment adviser.
However, that number masks wide variation among different plans, with the share of the individual systems invested in hedge funds ranging from zero to as much as 26.5%, according to Wilshire.
Hedge funds are privately managed alternative investments that are only open to sophisticated investors. The Hedge Fund Association says they “can use one or more alternative investment strategies, including hedging against market downturns, investing in asset classes such as currencies or distressed securities, and utilizing return-enhancing tools such as leverage, derivatives, and arbitrage.”
The nation’s largest state pension system, the California Public Employees’ Retirement System (CalPERS), invests only 2% of its assets in hedge funds. At the other end of the spectrum, the top-performing Missouri State Employees’ Retirement System (MOSERS) invests 30.9% of its assets in hedge funds. The Massachusetts Pension Reserves Investment Trust (PRIT) invests 9.4% in hedge funds.
The usefulness of hedge funds is a subject of debate. Asset-management firm Research Affiliates published a critical study last week that concluded: “Sadly, most diversified portfolios of hedge funds have largely failed to live up to their promises, delivering less diversification than investors were encouraged to expect, paired with inadequate returns, especially with their current swollen asset base.”
Raimondo defended the state’s strategy in an interview, saying the hedge funds will reduce the state portfolio’s volatility by exposing it to alternative assets such as commodities and currencies while reducing its correlation with the stock market, though it will also mean higher fees and lower returns.
“Yes, we may give up a little upside,” Raimondo told WPRI.com. “We’ve decided as a team on the State Investment Commission, given how risky the world is and how underfunded our plan is, it’s a prudent decision to maybe give up a little bit of upside in order to protect from the crash on the downside.” Rhode Island’s pension system lost $2.1 billion during the crash of 2007-09 and last year paid out more than it took in.
• Related: Chart: How Raimondo has changed RI’s pension investments (April 4)