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WRONG BET State's alternative fund gambits ill-considered

The position of the troubled Kentucky Retirement Systems that it shouldn't have to disclose what it pays to managers of hedge funds, private equity funds and other "alternative investments" doesn't wash. Further, a strong case can be made that KRS has no business investing in those kinds of funds at all.

The Lexington Herald-Leader reports that of $55 million in management fees paid by the KRS last year, at least $31 million went to managers of alternative investment funds, which according to the newspaper hold one-fourth of the retirement systems' assets and produced their lowest returns.

KRS officials won't disclose what they pay to individual fund managers, saying that the roughly 80 firms "prefer that their fees not be disclosed." So KRS has chosen the opaque approach, disclosing only the aggregate fees it pays for specific asset classes.

"We feel like we're giving our constituents the level of detail they need," KRS' interim chief investment officer, David Peden, told the Herald-Leader.

We disagree. First, this is public money, and people who accept public money - particularly when it is in the millions or billions - do so with their eyes wide open. Open Records Laws are ubiquitous and we are not aware of one that includes in its exceptions the fact that someone being paid for providing a service to government "prefers" that the fee not be disclosed. For a state agency like KRS to refuse to disclose such information on these grounds is nonsense, and it is offensive.

Further, the involvement of KRS with these types of investments at all is troubling. The Herald-Leader article points out that some of the investments have gone badly. The city of Fort Wright this month sued the KRS for allegedly squandering some of its pension money in "illegal and imprudent investments (and with) start-up funds with virtually no track record."

KRS also lost millions when it invested in a start-up fund that ended up being drained by its founder to support a luxurious lifestyle. It also invested in a second start-up venture that never launched.

In addition to the risks, alternative funds charge much higher fees than traditional investment funds, contributing to poor returns, of which there have been plenty in recent years. KRS officials defend the investments as a sophisticated way of protecting against a downturn, saying such funds tend to do better in bad markets.

But there's an easier, lower-risk way to accomplish that hedge - one long employed by mom and pop investors - and that is simply to invest a portion of one's portfolio in high-quality corporate bonds, which routinely outperform stocks in distressed markets.

We suspect the real reason for KRS' involvement in alternative investments is desperation. The funds face $17 billion in unfunded liabilities, due in large part to the state's failure to make the required contributions to maintain solvency for the past 15 years. And even that $17 billion figure is optimistic. It's based on portfolio growth projections that probably are not realistic. Last year's vaunted "pension reform" did little to genuinely remedy the problem, which will grow exponentially in the next few years if the state continues to underfund its programs.

The state's foray into alternative investments is in reality a search for yield - the sorts of home run investments that might give KRS the lift it needs to stave off painful near-term decisions. The system could buy Powerball tickets more cheaply, with about the same chance of success, in our view.

The KRS needs to be forthcoming about who it pays and how much with regard to pensioners' money. It also needs to forgo alternative investments and stick with the same sort of simple, low-cost investment programs the average taxpayer participates in.

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