Since South Carolina State Treasurer Curtis Loftis Jr. took office in January 2011, things have not been the same at the state’s pension fund. Loftis has come down hard on the South Carolina Retirement System Investment Commission. He has accused the staff of, among other things, paying its alternative assets fund managers fees that he says are undeserved. The former investment commission CIO, Robert Borden, who helped shape the investment portfolio’s focus on alternatives, resigned in December 2011, and the conflict has escalated since.
The fees have been a particular sticking point, since the state has invested at least 50 percent of its $26.6 billion portfolio in alternative assets. Loftis says that for fiscal year 2012 total portfolio fees amounted to $402 million on earnings of $125 million.
But even as Loftis has vociferously complained about fees, his ultimate frustration has to do with performance and how the investment commission has gone about its analysis. In an earlier interview, Loftis told Institutional Investor’s Alpha he would be fine with the commission’s alternative allocations if they earned enough to justify the fees paid last year. “If a hedge fund manager is making us a lot of money and we’ve done our due diligence, I want to shake his hand,” says Loftis.
So who exactly did the commission invest in, and how did these funds perform? Alpha obtained three different tables: one from the investment commission (based on calendar year 2012) and two from the treasurer’s office (based on calendar year 2012 and fiscal 2012 ended June 30). Each is different from the other.
According to the commission, the portfolio didn’t do too badly relative to the global index. Based on its latest performance review for 2012, overall hedge fund assets, with a market value pegged at about $4.77 billion, earned 10.84 percent last year, versus 3.5 percent return on the HFRX Global Hedge Fund Index, according to Hershel Harper, the CIO of the Investment Commission. (See Table 1).
Table 1: South Carolina Hedge Funds for Calendar Year 2012
Source: From South Carolina Retirement System Investment Commission
Of the 18 hedge funds and funds of hedge funds in the portfolio, the biggest holding is a hedge fund managed by Lighthouse Capital Management, which earned 11.4 percent. As of December 31, the market value of the Lighthouse fund was about $1.24 billion. (According to the fiscal 2011 annual report for the period ended June 30, 2011, Lighthouse was approved for an allocation of $3 billion “to facilitate the next phase of direct hedge fund investing and to provide a consolidated reporting platform for the total hedge fund portfolio,” according to the pension’s annual report.)
Of the 18, the top earner for 2012 was Grosvenor Capital Management, which returned 16.2 percent. At the bottom of the list was GAM U.S. Institutional Diversity, managed by GAM, which posted a minus 8.7 percent one-year return. Second lowest was hedge funds sponsored by Reservoir Capital Group.
But the two sides don’t see eye to eye on the numbers. Loftis, a Republican politician and businessman who has cast himself as a conservative reformer, calculates the pension portfolio’s returns differently, using audited fiscal year numbers. In prior years the commission reported its figures according to the fiscal year, which ends June 30.
According to Loftis, who says the fiscal year numbers have been audited but the calendar year numbers have not, hedge funds returned only 2 percent for the pension plan in fiscal year 2012. However, the fiscal year numbers do not include returns from four managers. By comparison, the portfolio beat the HFRX Index, which lost 5.8 percent in the same period. As of June 30, the total hedge fund portfolio was valued at about $5.17 billion. (See Table 2)
Table 2. South Carolina Hedge Fund Returns for FY 2012 (ended June 30)
Source: From the South Carolina State Treasurer’s office
Of the $5.17 billion, direct investments comprised ten hedge funds, valued at about $1.9 billion. The biggest of these holdings were funds managed by Mariner Investment Group, worth about $450.5 million.
The pension has invested more in funds of hedge funds, which stood at $3.2 billion. Lighthouse had the dominant share, with $1.24 billion. The next largest chunk was $692 million, managed by GSN.
The remainder was held in credit-oriented hedge funds, solely managed by Apollo Global Management, according to the treasurer’s list.
To further confuse the issue, the FY 2011 annual report said the portfolio’s hedge fund composite, comprising 22.2 percent of the total portfolio, returned 10.9 percent and had a market value of $5.6 billion, excluding strategic partnership exposures. The HFRX Global Hedge Fund Index stood at 4.2 percent for the equivalent period. (The hedge fund composite is divided between opportunistic and absolute return categories.)
Asked for a specific breakdown of hedge fund returns, both Loftis and Harper did not include opportunistic credit and global asset allocation returns.)
In addition to the 2012 fiscal year tally, the treasurer also provided Alpha performance numbers using calendar year data. This set of numbers contained slightly different information from the investment commission’s table. Loftis’s calendar year return stood at 10.4 percent on a total of $4.77 billion of hedge fund assets.
In a recent interview with Alpha, Harper, the former deputy CIO who later assumed Borden’s role, said that he has a mandate to earn 7.5 percent a year for the entire portfolio with minimal risk, and part of that includes investing in alternatives. According to the CIO’s calculations the overall portfolio earned 12.5 percent for the calendar year 2012.
Harper’s office, commenting for this story, said in an email that reporting both fiscal and calendar year numbers is the industry standard. “Picking out one number at only one point in time reflects a fundamental misunderstanding of what long term and pension investing is all about,” said the statement. “The calendar year 2012 returns are those as finalized by the Bank of New York, and the Commission is confident in them. The Commission welcomes, however, any evidence that they are unreliable or faulty.”
Loftis said, in an emailed response to a request for comment that the commission should rely on fiscal year numbers since that is the period on which the state’s budget and the state’s financial statements are base. The Retirement Systems’ financial statements are based on the fiscal year, and the investment commission’s annual investment report is done as of the end of the fiscal year on June 30.
“Even though external managers often have an incentive to overstate valuations to increase their fees, and readily determinable fair market values do not exist for most alternative investments, the Public Employee Benefit Authority and the Retirement System Investment Commission rely primarily on the valuations provided by external investment managers to value alternative investments owned by the South Carolina Retirement Systems,” the treasurer says.
Moreover, Loftis explains, some of the established alternative valuations are “questionable” because the commission’s consultant, Deloitte & Touche, concluded in an August 2012 risk assessment report that “due diligence and financial reporting controls cannot support the valuations provided by external investment managers.”
The commission’s auditor, CliftonLarson Allen, audited the Retirement Systems’ FY 2012 review. But, Loftis adds, the investment commission “has never had a full and separate independent audit of its financial statements.”
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