Kentucky Group Sues Funds, Alleges ‘Black Box’ Investing Led to KRS Woes

Plaintiffs allege the retirement system should have stayed with more vanilla index investments.

A group, including pensioners from the Kentucky Retirement System (KRS) and Kentucky taxpayers, is suing Blackstone, KKR, and other alternative investment funds for failing to produce returns as advertised. The class action is being led by Michelle Ciccarelli Lerach, a litigation attorney. The lawsuit also includes complaints against several former state pension officials.

In the complaint, plaintiffs allege that the retirement system should have stayed with more vanilla index investments, and that by going into “black box” alternative strategies, pension officials effectively made the retirement system insolvent. The plaintiffs also argue that the fund of funds structure led to excessive fees and sweetheart deals involving investment managers and pension officials.

“The claims are baseless,” wrote Matt Anderson, a spokesman for Blackstone, in a statement emailed to CIO. “The Blackstone fund referenced in the complaint delivered to the Kentucky Employees Retirement System positive returns outperforming relevant benchmarks.”

Defendants in the suit include several advisors to the pension, former pension officials, Blackstone founder Stephen Schwarzman, KKR Co-founders Henry Kravis and George Roberts, and the CEOs of Prisma Capital Partners and PAAMCO.

The defendants have argued that they are not in the wrong and that no one was swindled. Cara Major, a spokesperson for KKR, told CIO, “We take our fiduciary duty very seriously and believe that the allegations about our firm are meritless, misplaced, and misleading.”

While no investment comes with a guaranteed return, the complaint argues that the pension ignored its fiduciary duty by investing in fund-of-funds vehicles that were opaque and include many layers of fees. KRS has a long-term 7.75% return target  to meet its pension obligations. Plaintiffs argue that between 2011-2016, the pension’s absolute return allocation underperformed significantly and detracted from the pension’s overall return. KRS allocated $1.2 billion to its absolute return portfolio in 2011-2016. In late 2016, the pension approved a plan to unwind its absolute return portfolio. The pension portfolio failed to meet its return targets throughout the period outlined in the complaint.

Kentucky’s retirement system is one of the worst-funded in the nation. The pension has hovered around 30% funded status for several years. The pension system has been chronically underfunded by the state legislature, and pension trustees have also approved a run of bad investments over the past decade. The state Attorney General is already involved with a lawsuit against Gov. Matt Bevin for his reorganization of the KRS Board of Trustees. Additional legal action could be forthcoming as Bevin has indicated that pension reform is on his legislative agenda for 2018.

The Governor has called on Kentucky’s municipalities to start making larger contributions to cover the funding gap, a move which is already drawing considerable pushback as city officials cite shoestring budgets and low tax revenues. As highlighted in

The Richmond Register, many state workers have also opted to retire if they were eligible in order to lock in a certain level of benefits as the Governor examines considerably pared-down pension plans for new employees and considers benefit cuts for those already in the pension system.

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