WHEN the hedge fund Amaranth Advisors flamed out last year after disastrous bets on energy prices, San Diego County’s retirement fund was among those burned. Losses to its portfolio were estimated at $100 million.
The episode is unlikely to stem the rising tide of pension dollars into hedge funds. It has, however, raised concerns about the safety of retirement money and stirred debate on whether more oversight is needed.
“Amaranth is a glaring example of the loss that can take place and the risk that exists when public pension systems invest in hedge funds,” said Lani Lutar, president of the San Diego Taxpayers Assn. “At the end of the day, taxpayers could be left holding the bag.”
Hedge funds utilize an array of trading techniques to pursue lucrative returns, sometimes shifting strategies with dizzying speed and often using debt to enhance the payoff. Retirement plans, facing burdensome financial obligations in the future, will have nearly $200 billion in these funds by 2010, said Daniel Celeghin, associate director of consulting firm Casey, Quirk & Associates.
The trend may also prod some retirees to keep an eye on how their pension money is being invested and to examine whether new risks are entering the picture. Getting the information may take some effort, however -- and some funds make it easier than others.
Big public pension funds such as the California Public Employees’ Retirement System typically offer investment information right on their websites.
Beyond that, public funds also have open board meetings and are subject to freedom of information laws that generally require the disclosure of investment details.
“The way you have input is to engage with the fund board and urge them to be extraordinarily careful,” advised Richard Ferlauto, director of pension and benefit policy at the American Federation of State, County and Municipal Employees. “If there is an active member representative or retiree representative,” he added, “you should call them up and tell them how you feel.”
Private firms have maintained that their liability for pension benefits means that they control the investment decisions. Yet here too there are ways to investigate, experts say.
Corporate pension plans lay out investment details on a Form 5500, which is filed annually with the Labor Department. Plan participants may request such information from the agency by calling its public disclosure office at (202) 693-8673 -- there’s a time lag, however, so the information may not be up to date.
Details also may be provided in the annual report or summary plan description that participants receive yearly. And you can call your company or the outside firm hired to administer your plan.
“If you’re a retiree, and you want to get an answer, and you want to get an answer without a lot of hassle, the way to maximize your chances is to call -- not write -- the office of the plan administrator,” said Damon A. Silvers, associate general counsel of the AFL-CIO. “When someone picks up the phone, you say, ‘I’m a retiree. I have a couple of questions about how the plan is being managed. Is there someone I can talk to?’ ”
Even if you manage to learn some details about hedge fund investments, however, it is no simple matter to assess their significance, experts caution. Hedge funds often operate secretively and disclose little. They employ widely diverse strategies, and they vary in risk.
The Securities and Exchange Commission has sought to impose greater regulation on hedge funds but suffered a setback last year when a U.S. appeals court tossed out an SEC rule that required hedge funds to provide information including their ownership and details of legal problems.
“For many of these funds, lack of transparency is part of the business model -- and this is ridiculous,” said Stephen J. Brown, a finance professor at New York University’s Stern School of Business.
In February, a Bush administration working group concluded that discipline of the marketplace was sufficient to safeguard investors. Still, the lack of oversight and transparency means that hedge fund investors have a particular burden to learn about the risks they are taking on, observers agree.
Hedge funds vary widely in the quality of their internal controls and disclosures, said Barbara Lucas, a partner at Capital Market Risk Advisors, a financial advisory firm.
When it comes to the quality of hedge fund operations, “we see the good, the bad, the ugly and the indifferent,” said Lucas, a longtime securities attorney. “It’s really all over the place.”
Hedge fund enthusiasts contend that such investments have jumped in popularity because they can produce reliable returns that are steadier than stocks and higher than bonds. When stocks plunged after 2000, for example, many hedge funds stayed strong.
Strategies include using leverage (a reliance on borrowed money that can supercharge gains or losses) or short-selling stocks (betting that shares will decline in value).
About 10% of big pension funds now have stakes in hedge funds, the Casey Quirk consulting firm estimates, and that’s expected to hit 18% in the next few years.
CalPERS, for example, has allocated about $4.6 billion to more than two dozen hedge funds and other alternative investments, including funds that trade in currencies, global commodities, European hedge funds and emerging markets, since 2002. The returns have been about 10% annually -- comparable to major stocks and more than triple that of one-year Treasury bonds.
“It’s a good way of hedging your bets,” said Clark McKinley, a spokesman for the $243-billion CalPERS system. “We have not been burned with hedge funds.”
Yet the Amaranth blowup has caught the attention of officials in Washington, who see it as a potential red flag.
Public plans are in effect guaranteed by the taxpayers, raising at least the possibility of a costly bailout if such a plan ever went belly up. (Corporate pensions are largely ensured by the Pension Benefit Guaranty Corp., which is financed by insurance premiums from employers and other sources.)
Sen. Max Baucus (D-Mont.), chairman of the Senate Finance Committee, recently asked the U.S. comptroller general to examine potential dangers of pension funds investing in hedge funds. In the House, Rep. Barney Frank (D-Mass.), chairman of the House Committee on Financial Services, and Rep. George Miller (D-Martinez), chairman of the Education and Labor Committee, also are looking into the matter to see whether new safeguards are required, such as possible limits on whether pensions should invest in hedge funds.
“It’s something we have a concern about,” Frank said, adding that he had not decided whether congressional action would be necessary to safeguard retirees and taxpayers. “We’re talking about it. This is on our agenda.”
Amaranth helped put the issue front and center.
In 2005, the San Diego County Employees Retirement Assn. plan invested $175 million with the fund, a global trader in commodities and financial instruments based in Greenwich, Conn. The following year, as the effect of Hurricane Katrina faded, Amaranth made a series of disastrous bets on the future of energy prices.
In September, that market collapsed -- and so did the hedge fund, which reported a loss of $6 billion.
The San Diego retirement association contends that the hedge fund repeatedly misled it about its strategies and actions in the marketplace. In March, the retirement system brought suit in federal court, seeking $150 million for its losses and damages.
The suit claims that Amaranth employees touted the benefits of the fund’s diverse trading strategies and sophisticated controls to limit losses. Moreover, Amaranth “repeatedly maintained” that it was not making large bets on the future of gas prices, and as late as August 2006 employees of Amaranth assured San Diego that the risks of energy trades had been “appropriately decreased and hedged,” according to the suit.
“They were telling us one thing, but they were doing something else,” Brian White, chief executive of the retirement plan, said in an interview.
But Amaranth attorneys said San Diego County received “very clear risk disclosures” before it chose to sign up with the fund. Pension officials were provided a “confidential private placement memorandum” that was filled with warnings, including on the fund’s lack of requirements to diversify and its use of leverage.
One document, obtained by The Times, included a prominent warning that the investment involved “substantial risk” and cautioned that “investors must be prepared to lose all or substantially all of their investment in the Fund.”
It also noted that there were no material restrictions on the strategies, leverage or markets in the portfolio, or the percentage of assets “that may be committed to any particular strategy” or approach and that investors should base their decisions to invest “solely on the basis of the information set forth” in the document.
But Dan Webb, a partner at law firm Winston & Strawn who is representing Amaranth, described San Diego County as a sophisticated investor that sought out investments that could outperform traditional stock and bond funds.
“Apparently, risk is a good thing for [San Diego County] when it produces outsized returns, but is unlawful when it produces losses,” Webb said.
One day, a court will decide who is right. But in the meantime, the San Diego County’s pension fund does not plan to back out of hedge funds and other alternative investments -- in which it has more than $1.2 billion of its $8 billion in assets.
Even with the big Amaranth loss, San Diego County last year enjoyed overall returns of 14.57%. According to White, hedge fund and alternative investments serve as a prudent counterweight to Wall Street’s mainstream stock funds.
“When you put them all together, they’re actually less risky,” he said.