Beware Real Estate Hubris
In the late 1970’s/early 1980’s, AT&T unveiled an attention grabbing new corporate headquarters on Madison Avenue — complete with its chippendale crown. On 1/1/84, however, AT&T was dismantled, broken up into its regional operating companies. Twenty-five years later, Lehman brothers presented its sleak new global headquarters. And, poof in September of 2009, Lehman was no more.
Remembering this architectural and corporate history, I read with great interest about 510 Madison Avenue — a fancy new “trophy” home for hedge funds.
Could this herald the beginning of the end of hedge funds?
The Times reported, last week, that 510 Madison suffered a significant detour (namely the ’08/’09 financial crisis) in its quest to capture $100/ft rents paid by ever-flush hedge fund managers. Under new ownership and a brighter financial environment, however, high-end amenities are once again playing well to the Hedge Fund set.
Characterized as “more like country clubs, than workaday offices”, 510 Madison includes, a spacious lobby, restaurant, pool, and fortunately, a landscaped terrace. I mean doesn’t everyone need a terrace to relieve the stress of managing $ billions of other people’s money.
And yet, here’s the problem …. It is other people’s money (OPM) as the cognoscenti well know.
While many hedge fund investors include high net worth and super high worth individuals — presumed to be sophisticated and capable of making their own investment decisions — most hedge fund managers also welcome the deluge of pension assets they have received over the past decade (as long as the pension assets don’t constitute more than 50% of the fund.)
It is not too hard to connect the dots and recognize that the hard earned pension assets of millions of workers are supporting the lavish work digs (not to mention the mansions, summer homes and private planes) of many hedge fund managers.
Sarcasm aside — plan fiduciaries must answer a pretty difficult question before investing assets in a hedge fund. Are the “2 and 20” fees (2% management, 20% performance fees) justified? Or, more appropriately are these fees “reasonable”. Hedge fund managers can only afford their toys and lush office towers because fiduciaries sign-off on these fees. And remember, ERISA requires that the fees be reasonable.
Last year the S&P 500 returned slight more than 15%, whereas the Barclay Hedge Fund Index returned 10.9% (other indices reported even lower performance). That is pretty expensive underperformance for 2010.. Of course, one year is not a fair comparison. However, before any fiduciary can justify investing in hedge funds, they need to examine, carefully, very carefully, the 3, 5 and 10 year performance returns.
Pension plans are under enormous pressure to generate competitive returns. Unfunded pension liabilities are staggering. However, reaching for the latest hedge fund du jour can lead to disappointing and mediocre investment results.
The beauty of the hedge fund business model, however is that even if performance remains mediocre, the managers remained ensconced in their fancy offices, sipping lattes on the landscaped terraces. Unfortuantely, the brunt of the pain is borne by the pension plan investors.
Certainly, ERISA didn’t contemplate these results. And someday, fiduciaries are going to have to justify the reasonableness of their actions in authorizing these investments.