Marc Levine, chairman of the Illinois State Board of Investment (ISBI), didn’t mince words on why he decided to remove hedge funds from the board’s investment portfolio: they were confusing and underperforming, with unjustified high fees. Levine started the culling process two years ago, when he became chairman of the $22 billion entity.
“I had been reviewing the Board’s portfolio and noticed a lot of holdings labeled hedge funds. They were run by something called a “hedge fund manager,” whatever that was. Most bought and sold stocks—but so did other funds we owned that showed up under the category “stocks” and were run by “equity fund managers,”” he wrote in a column for The Wall Street Journal.
“I had been appointed in 2015 and we were taking a fresh look at the portfolio. We decided to reduce the allocation to hedge funds from 10% to 3%,” Levine told CIO, adding that the Board’s decision was unanimous. “We met with our hedge fund of fund managers during a two-day investment committee meeting.”
Although the hedge funds also bet on equities, as well as commodities, derivatives, and other vessels, they were underperforming, with fees feeling unjustified. In addition, their returns were only benchmarked against other hedge funds in the HFRI. After the ISBI applied the proper market benchmarks to that of the hedges, heads began to roll for the asset class, as the board proceeded to cut nearly all of the hedge fund managers. Some were moved to the equities side of the portfolio, newly christened as “equities managers,” but Levine, who favored the ISBI’s bonds and a long-only strategy, had made his interests clear. It was time to stick to passive in order to preserve the fund for future generations.
“Some of our equity guys were pretty good,” he said. “In maybe July or so of last year, we decided to just zero out the hedge fund category completely and then the guys who picked stocks, we just moved them along into our equity book, which is where they belong. The guys we retained have massive alpha. They all have at least 300 basis points, sometimes 1,000 over a long period of time, and they’ve kept those numbers up.”
As for where the remainder of the hedge fund portfolio went, the ISBI moved the money to its fixed income portfolio, mostly as bonds, which Levine still feels is underweighted. “We didn’t have any opportunistic credit, and now that category is 8% for us,” he said. “It’s basically unleveraged. We love that asset class.”
Levine says the board, which oversees the pensions of five pension plans (the State Employees’ Retirement System, the General Assembly Retirement System, the Judges’ Retirement System of Illinois, the Illinois Power Agency, and the State of Illinois Deferred Compensation Plan), has saved $75 million per year in money manager fees. In the last fiscal year, ISBI saw 12.3% returns.
Illinois is currently undergoing a pension crisis, with a pension deficit of $129 billion. When asked of a recent concept of a titanic bond sale being introduced to state legislators, Levine suggested that rather than have a professor explain the idea, lawmakers need to speak with capital markets professionals. Although Levine admits that there are some silver linings in all of this, it’s more of an issue of reform and restructuring than just a simple bond buy.
“Who is going to buy these bonds?” he asked.
“I’ve spent my life in the financial markets [and] I cannot imagine that there are investors out there who are going to take all of the risk off of the taxpayers and pension beneficiaries and take it on themselves,” he said. “Having said that, I think it’s a worthwhile issue to look at—not in the context of $109 billion—but it’s certainly preferable…if some of that [state credit risk] could be shifted over to bond holders who are willingly doing it, that’s a good thing, but the only way that’s going to happen in my view is some kind of pension reform or restructuring.”
As for reform plans, Levine opined on his own behalf that it’s going to have to come to a Federal level for things to be on their way to restructure.
“The state supreme court voted 7-0 almost three years ago that took pension fiscal management out of the hands of the legislature, which is problematic. The only way I know of to get it back in the hands of the legislature is for the Federal government to pass a Puerto Rico-style restructuring type bill,” he said. “You really need your lawmakers to deal with these fiscal problems and where we’re sitting, ever since that decision, they can’t. Somehow that’s got to be fixed. You really need a federal bill to enable the state to utilize US bankruptcy laws to restructure its liabilities.”
“I’m not talking about a bailout, of course. That’s not going to happen,” he said.