Compatibility of pension funds, hedge funds questioned at hearing

WASHINGTON — The possibility of limiting pension fund involvement in hedge funds was raised last week by legislators and hedge fund industry representatives at a hearing on Capitol Hill on how much risk hedge funds pose for financial markets.
“Limitation on who gets in [to hedge funds] needs to be reviewed, whether it’s the individual’s net worth standard, whether it’s pension fund management capability” or limits on funds of funds, said Rep. Richard Baker, R-La., summing up comments made at the hearing held by the House Financial Services Committee.
Current minimum investments of $25,000 in funds of funds, which contain hedge funds, are “highly inappropriate,” he said.
Several members of the committee questioned how risky hedge funds are to pension funds that invest in them. Pension beneficiaries, who are not sophisticated enough to understand the risks of hedge funds, could be harmed if their pension funds lose money from hedge fund investments, said Rep. Al Green, D-Texas.
“They’re the people who lose,” he said. “And then the taxpayers pick up the tab,” Mr. Green said, asking if Congress should take action to try to prevent problems.
“The concern you should have is, who [is] running these [pension] funds,” commented Jeff Matthews, general partner of Ram Partners LP, a hedge fund in Greenwich, Conn. “If they’re making bad decisions regularly, that’s a real problem. The hedge fund is just doing its job, and I don’t know if you can regulate that.”
Chairman Barney Frank,
D-Mass., said that the committee will look at hedge fund investments by public pension plans, which are not subject to the same regulations as private pension plans. “One of our concerns [is] the public pension funds,” he said.
Although some members of the committee expressed concern about whether hedge funds pose a risk to U.S. financial markets, hedge fund industry representatives testifying at the hearing countered that hedge funds are less volatile in general than the U.S. stock market.
Although there have been two high-profile Greenwich hedge fund disasters in recent years — Amaranth Advisors LLC last year and Long-Term Capital Management LP 1998 — the Standard & Poor’s 500 stock index only recently returned to the levels it had been at before 2001, said George Hall, a director of the Washington-based Managed Funds Association and founder and chief investment officer of Clinton Group Inc., a New York hedge fund.
In contrast, Mr. Hall said, hedge funds actually have generated positive returns with less volatility than the stock market. “The reality is that common equities in most cases may be more risky than the overall hedge fund market.”
There was general agreement that the Securities and Exchange Commission should approve its proposal raising the wealth threshold for individual hedge fund investors to $2.5 million of investible assets from the current standard of $1 million total net worth, but some questioned whether net assets is the best measurement of who should be investing in hedge funds.
When he first broke into the business, famed investor Warren Buffett — who ran a hedge fund for 20 years — would not have been an accredited investor under the SEC-proposed standard, said Jim Chanos, founder and managing partner of New York hedge fund Kynikos Associates Ltd. and chairman of the Coalition of Private Investment Companies, a coalition of hedge funds.
“These numbers are arbitrarily policy-driven numbers, not economic numbers,” he said. “So the industry and the proper authorities have to coalesce around figures that broadly represent the ability of investors to shoulder risk.”
Industry representatives also suggested that hedge fund disclosure requirements should focus on disclosures by hedge funds to regulators concerning any risks they may pose to markets, in addition to confidential disclosures between hedge funds, investors and prime brokers that finance them.
In the context of financial stability, there is more “pay dirt” in those types of disclosures than there is in public disclosure, said Gerald Corrigan, a managing director of The Goldman Sachs Group Inc. of New York and co-chairman of that firm’s risk management committee.
That is due, in part, “because public disclosure is suffering from a very chronic information overload problem,” he said. The industry needs to develop best practices for disclosing information, Mr. Corrigan said.