New York Department of Financial Services (DFS) Superintendent Maria T. Vullo released a report saying the New York State Common Retirement Fund (CRF), the investment arm of the New York State and Local Employees’ Retirement System and the New York State and Local Police and Fire Retirement System, for years has invested pension system funds in high-cost, underperforming hedge funds and nontransparent private equity funds. 

The concerns highlighted in the DFS report are in contrast to actions taken by state pensions nationwide, which have widely cut or eliminated similar investments.

The report alleges that the New York State Comptroller has over-relied on active management by outside hedge fund managers, who consistently have underperformed low-cost diversified index investments while charging “huge” fees. “Over the last fiscal year alone, the CRF has paid more than $150 million in fees to hedge fund managers for managing $8 billion in assets, or approximately 4.5% of the fair value assets of the System. In comparison, CRF paid $59.2 million in fees and commissions for the substantially greater $61.5 billion invested in domestic equities, 34.5% of the fair value assets of the System, representing less than one-tenth of the 1% fee on assets under management,” the report says.

In addition, the report alleges that CRF has paid out $1 billion in fees to hedge fund managers over the last eight years, while these assets have under-performed, costing the system $3.8 billion in excess fees and underperformance. It notes that hedge funds are the worst of the six asset allocation classes with a 10-year record.

The report accuses the State Comptroller of continuing to put money into hedge fund investments despite years of poor performance―increasing by 86% the system assets put into hedge funds by 2016.

According to the DFS report, in each of the past eight years, the System has paid excess fees of at least $40 million (in 2009 and 2010) and at least $100 million in every year since (including $240 million in 2014) in an apparent effort to boost returns―returns, the report says, that could have been easily achieved through broad index funds.

Vullo accuses the Comptroller’s Office of not putting into place adequate controls to address transparency issues with the system’s investments in private equity, where the managing general partners may be imposing hidden costs and expenses that would otherwise have been credited against fees already owed, and paid, by the limited partner investors, she says. 

The report notes that although private equity as an asset class has reported above average returns over the past decade, management’s control and discretion over the valuation of privately-held assets―for which there often are no independent market-set values―leaves open the real possibility that when the investments are redeemed, some portion of the excess profits will vanish as market prices replace mark-to-model theoretical prices.

Based on its findings, DFS is considering certain regulatory reforms for the hedge fund investments, as well as reforms proposed in the report to address the lack of transparency of the private equity investments. DFS will examine these issues in upcoming examinations, and will release reports as necessary to serve the public interest.

In addition to the California Public Employees’ Retirement System (CalPERS)―the nation’s largest public retirement system―eliminating its hedge fund investments in 2014, last month, California Governor Jerry Brown signed AB 2833, sponsored by State Treasurer John Chiang, requiring public pension funds to disclose fees paid to private equity investment firms.