The governing agency for the San Diego city employee pension fund is weighing investment in private equity funds, or privately managed partnerships, something the fund has never done before.
Such investments are similar to hedge funds in that they aren’t registered with the Securities and Exchange Commission, aren’t as liquid as stock and mutual funds and carry higher management fees.
However, pension officials assert that private equity funds aren’t hedge funds in that they have more clearly defined investment strategies and are managed for long-term appreciation, not short-term gains.
“We feel a responsibility to look at this asset class as a potential investment,” said Tom Hebrank, chairman of the investment committee for the San Diego City Employees’ Retirement System. “This doesn’t mean we will get into it.”
Hebrank, a certified public accountant with Douglas Wilson Cos., said the CERS board voted Nov. 17 to learn more during the next six months before deciding whether to invest part of the fund’s $4.6 billion in assets in these vehicles.
The CERS fund has been at the epicenter of the city’s fiscal crisis and has an unfunded liability, or total future debt, of more than $1.4 billion. The fund has more than 17,000 active and retired members.
Given the enhanced returns private equity funds have earned in recent years, both public and private pension funds have made investments in such vehicles. The California Public Employees Retirement System has invested 7 percent of its total assets, or about $12.3 billion into private equity funds, Hebrank said.
The county pension fund, now at $7.3 billion in assets, has been investing in private equity funds. Its exposure is 3.36 percent of the fund, or $261 million, said David Deutsch, the fund’s chief investment officer.
Those funds are invested in 53 different partnerships and have posted an annual return of 17.8 percent for the year ended June 30.
Both the city and county pension funds are generating above average returns. CERS reported a 10.6 percent return for the 12 months ended Sept. 30. The county’s fund reported a 14.9 percent gain for its fiscal year ended June 30.
The CERS board is investigating private equity funds because of the failure of Connecticut-based Amaranth Advisors, a hedge fund in which the San Diego County public employee pension fund invested $175 million. In September, Amaranth lost two-thirds of its value after making a failed bet on the price of natural gas.
Despite the meltdown of Amaranth, county pension fund officials said that even if the fund loses all its money, it would still enjoy profits this year. The county has about 20 percent of its $7 billion pension fund in higher-risk and hedge funds.
Doug McCalla, CERS chief investment officer, said private equity funds differ from hedge funds in that they are not as concentrated in a particular strategy, or as highly leveraged.
“You’re not investing in trading strategies, but in operating companies before they go public,” McCalla said.
The distinctions aren’t easy to pin down because there are thousands of private equity funds and hedge funds, some of which use multiple investing strategies.
In general, private equity partnerships invest in early stage companies for longer terms. Hedge funds usually carry more volatility and invest in higher-risk vehicles, such as the future prices of commodities, as Amaranth did, McCalla said.
Hebrank said the board hopes , if it decides to invest in private equity funds , that it will find the next Google or eBay, two wildly successful public companies launched in the 1990s.
Hebrank also said he was opposed to public pension funds investing in hedge funds due to their risk.
While there may be differences, private equity funds share certain traits with hedge funds, including not being registered with the SEC, lack of liquidity and carrying higher management fees than regular stock funds.
According to a presentation by CERS’ actuarial consultant, Callan Associates, private equity funds charge 20 percent of profits made in addition to an annual 2 percent asset management fee.
Hedge funds also charge higher interest on whatever earnings the funds generate on top of annual management fees.
Another downside is that the funds may not generate returns in their early years.