No easy way to separate politics, state investment

Rhode Island gubernatorial campaigns usually don’t spend too much time debating the merits of different hedge funds.
But the public-pension fights of recent years have thrown previously under-the-radar investment decisions into the spotlight in 2014.
Last month, the state Investment Commission, led by General Treasurer Gina M. Raimondo, a Democratic candidate for governor, pulled $74.3 million out of Third Point Partners, a hedge fund controlled by billionaire investor Daniel Loeb.
The move drew questions, because Third Point has been the Rhode Island pension system’s top-performing hedge fund, returning 22 percent since Raimondo added it to the portfolio in Jan. 2012.
Loeb, an outspoken supporter and financial backer of education-reform groups, has also drawn the ire of teachers’ unions opposed to his promotion of charter schools and teacher accountability.
Raimondo said the move out of Third Point was made to reduce risk and had no basis in politics, but a Wall Street Journal editorial called it a “cave in” to secure union support in a competitive Democratic primary.
Whether Loeb’s political activities played any part in the Investment Commission’s decision to leave Third Point is unclear, but at minimum the move has renewed yearlong questions about how public money is invested and whether the process has become politicized.
Last summer Providence Mayor Angel Taveras, one of Raimondo’s primary opponents, criticized the treasurer’s use of hedge funds after the issue had been raised by opponents of the state pension overhaul she led.
Taveras’ criticism followed his decision to move $11 million from the city’s pension system out of hedge funds last year, bringing the percentage in hedge funds below that of the state’s 15 percent target.
But, while Taveras said the move was made to reduce costs and risk, some questioned whether it was also part of a strategy to tie Raimondo to Wall Street and the financial industry.
The current Rhode Island system, with the treasurer leading an independent investment board, is designed to try to insulate public-investment decisions from politics, at least in part, as are, to some degree, appointed pension boards in cities and towns. John Marion, executive director of Common Cause Rhode Island, said the state system “splits the difference” between guaranteeing political accountability for investment decisions and insulation from partisan calculations.
“The two extremes include leaving decisions only in the hands of political appointees or alternately in the hands of technocrats,” Marion said. “In the former you risk that all decisions will be made for political reasons and in the latter you risk that there is no chance for political accountability.
“I think [the current system is] the right balance, because the alternative institutional arrangements would mean we aren’t getting the benefits of the private-sector experience and the voters couldn’t send a signal about what values they want in our public investments,” he said.
On top of the still-simmering pension dispute, Brown University political science professor Wendy Schiller said the debate about hedge funds and Wall Street’s role in managing public money is likely to remain potent in this election cycle. That’s because so many of the candidates come from working-class backgrounds, and their paths to politics have been central parts of their campaigns, compared to some of the more-patrician candidates of the past.
“Certainly Taveras will try to make Raimondo look cozy with Wall Street, rich and out of touch – that has been working for him so far,” Schiller said. “But the mayor’s biggest problem is if the state pension deal remains intact, she looks like someone who tackled this problem, and he still has a pension hole looming.”
Still, Schiller said there’s no perfect way to get politics out of public investing and ultimately the voters need to sort it out.
“But when you are dealing with taxpayer money, it is very difficult to take politics out of that. The only way is a blind trust, but then you have no control,” Schiller said.
Since the Investment Commission began expanding its hedge-fund portfolio in 2011, Raimondo has said her intention is to diversify the pension fund’s holdings and reduce exposure to stock-market volatility, not chase gains.
Critics, including Taveras, have pointed out the high fees that hedge-fund managers charge and the hedge-fund investments have coincided with a roaring stock market that has outperformed them. The decision to leave Third Point, according to Raimondo spokeswoman Joy Fox, was to reduce the pension system’s “beta risk,” a measurement of both investment volatility and correlation with the broader market.
When the $74.3 million is redeemed from Third Point, about $20 million will be reallocated to Samlyn Onshore Fund, which will have the largest piece of the Rhode Island hedge-fund portfolio at about $100 million.
The Investment Commission first put money in Third Point and Samlyn in January 2012, with investments of $50 million and $60 million, respectively.
Since then, Third Point has made $24.3 million, 22 percent, and Samlyn $16.4 million, 17 percent, the second-highest rate or return among hedge funds in the portfolio.
The driver of divestment from Third Point was the fund’s 0.39 beta, Fox said, compared with Samlyn’s 0.18 and an average of the other hedge funds of 0.19. (The higher the number, the more closely correlated with market moves it is and the greater the average size of its swings in value.)
The Investment Commission’s monthly reports do not include beta measurements, but do include standard deviation, a measure of volatility that doesn’t account for market correlation.
Historically Third Point has been the most volatile of Rhode Island’s hedge funds, with a current five-year standard deviation of 10.4 percent compared to Samlyn’s 7.7 percent.
But Third Point’s deviation has been dropping, from 15.2 percent three months after Rhode Island made the investment in 2012. In the last two years it has been 5.8 percent.
“While the commission was aware of Third Point’s beta risk when it invested in January 2012, the circumstances were different then,” Fox wrote in an email. “Today, the equity market is about 50 percent higher than it was then. Based on current market conditions, the [investment commission] wanted to lower further the equity beta of the hedge-fund portfolio and decided to do so by exiting and locking in gains from the highest beta fund.”
Democratic primary opponents Taveras and Clay Pell did not immediately respond to requests for comment. •

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