Credit-Related Strategies Warrant Heightened Scrutiny
It’s called the Great Liquidation. As reported in today’s NYT, The Haggling for Troubled Assets Begins, “hundreds of billions of dollars of bad investments …are going up for sale”. Fiduciaries must ensure that these bad investments do not end up in retirement plans.
Notwithstanding TARP, QE1 and QE2, financial institutions still hold impaired or “bad” assets. This simply means that the assets are still held by institutions at values that are likely far in excess of their fair market value.
And so, the Great Liquidation begins. The term — coined by Fortress Investment Group — refers to the prediction that “you’re going to see in the next five years, more financial asset liquidations than you’ve seen in the sum total of the past 100 hundred years.” An exaggeration? Ok, let’s assume it’s simply more than in the pat 50 years – that’s still a lot of assets being put up for sale.
If this appears daunting, don’t worry. Fortress already has $12.7 billion of assets devoted to credit-related private equity and hedge funds. No doubt the entire spectrum of the Wall Street herd — investment banks, commercial banks, hedge funds and private equity firms — will be bulking up in this area, if they haven’t already.
Just imagine a 2% management fee and 20% of profits on “hundreds of billions of dollars”. Now that’s a nice bonus pool!
Before the Great Liquidation Orgy (my term) begins, however, Wall Street is going to need to raise money to indulge in this financial bacchanalia. Certainly there will be private investors, wealthy individuals, sovereign wealth funds. But the $16 trillion pool of pension assets is the granddaddy of all funding sources.
I can just see the entire pension investment consulting industry working itself into a frenzy cranking out their graphic laden presentations recommending Credit Related investment strategies and firms. The graphs and the statistics, no doubt will be very impressive – worthy of PhDs. But Beware. “Its déjà vu all over again”.
Think back to the early 90’s. Who had heard of hedge funds? Private equity firms were still referred to as LBO firms. In terms of financial markets and products it was a different era. As the new century dawned, however, investment strategies and products exploded in complexity. Simultaneously, in order to remain relevant, the pension consultants began touting these new products.
In time, consultants were recommending significant shifts in allocations to “Alternative Investment Classes”. It was not surprising to see allocation recommendations of 8%, 10%, 15% or more to alternative asset classes. In fact, in the summer of 2008, I had lunch with the Chief Investment Officer of a university endowment who said that they had allocated 45% of the endowment to hedge funds.
We all know the outcome of this story. In the end, the investment returns of many plans were negatively affected by these allocations. No one knows yet, if in the long run the plans were better off or worse for these significant allocations to Alternative Asset Classes.
We do know one thing, however. Consultants merely make recommendations. Plan fiduciaries hold the real power in making allocations to asset classes and to specific managers.
Without a doubt fortunes will be made in the course of the Great Liquidation. The question is whether retirement plans need to venture into this arena. Fiduciaries must invest assets prudently. When a new asset class emerges, such as credit-related investments, how is a manager evaluated? What’s the track record? How is risk measured? How are projected returns evaluated against the risks that are assumed? What about due diligence on investments?
The list goes on and on.
The Media is going to feature the newly minted credit-related billionaires. Investment returns may likely be huge. The allure of jumping into these investments will be strong. The consultants will be putting on a hard press.
Plan fiduciaries must be very wary. For those who do decide to play in this game, make sure you do your homework. Remember, you are investing other people’s hard earned retirement dollars. Keep the financial debacle of 2007-2009 at the forefront of your mind. And, tread carefully.