This past week, the American Federation of Teachers, one of the U.S.’s largest teacher unions, issued a list detailing specific hedge funds it was urging pension funds to stay away from. The 33-fund compilation, which acts as a blacklist, has some of the hedge fund industry’s biggest names on it, including Carl Icahn, Steve Cohen, David Tepper, and Daniel Loeb.
In the investing world, there’s plenty of drama between hedge fund managers. Take the Bill Ackman-Carl Icahn battle over the legitimacy of Herbalife’s business model, for example. Not as often, though, do we come across a group of organized investors lining up against hedge funds.
Interestingly, that’s just what has happened with the American Federation of Teachers and a proverbial blacklist published this week, urging pension funds to stay away from 33 specific funds.
What’s the AFT’s motivation?
Earlier this week, the AFT president, Randi Weingarten, singled out one hedge fund manager in particular: Dan Loeb, founder of the New York-based hedge fund Third Point.
According to a story by the NYPost a few days ago, Weingarten’s main beef with Loeb is his ties with StudentsFirst, an organization that describes itself as “a grassroots movement to reform America’s public education and keep our best teachers in the classroom.”
More specifically, part of StudentsFirst’s reform package would be to eliminate defined benefit plans for pensioned teachers, among other publicly employed workers.
After Weingarten and the American Federation of Teachers threatened Loeb to show up at a conference in Washington on Thursday, where he had planned to speak with Barry Rosenstein of JANA Partners, as Business Insider reported.
Interestingly, Loeb withdrew from the event yesterday, and according to the Post, his panel’s moderator was Anne Sheehan, the California State Teachers Retirement System’s Director of Corporate Governance. On Loeb’s decision, Sheehan told reporters that she “deeply regret[s] but understand[s].”
What’s the philosophical basis?
On StudentsFirst’s official site, the organization mentions that fiscal problems have forced states to adjust their budget practices, and one way would be to “move from defined benefits to retirement plans that are more sustainable and can be immediately accessed by all teachers.”
Obviously, many AFT union members and one heated Rolling Stone reporter believe that Loeb and any other hedge fund who support a switch away from a defined benefit plan to a self-directed retirement package, in which teachers would not receive a guaranteed payout post-employment, are hypocritical.
As Rolling Stone’s Matt Taibbi so clearly puts it, “Loeb has been soliciting the retirement money of public workers, then turning right around and lobbying for those same workers to lose their benefits.”
Thus is the basis for the blacklist.
Are state pension funds pulling out already?
According to the Post, the Illinois State Board of Investment, with more than $12 billion in assets, uses the services of EnTrust Capital, which has invested over $30 million of the ISBI’s money in Loeb’s hedge fund. In a letter to EnTrust (acquired via the Post), the ISBI’s Executive Director, William Atwood, wrote the following:
“It would be troubling and embarrassing to now find that one of the firms retained by Entrust on [our] behalf is using the fees paid by [our] participants to work against their interests.”
It is also rumored that the Ohio Public Employees Retirement System has a similar beef, the Post’s sources say.
What’s the reality?
This thought process is sensible, and with an estimated $800 billion in AFT funds nationwide, pension funds will always be one of the largest clients invested in the hedge fund industry. In other words, their thoughts matter.
In some critics’ eyes, it may be troubling to see the ISBI, Weingarten, and other players in the pension fund industry to have what seems like a short-sighted argument. After all, if Loeb, StudentsFirst, and the rest of the opposition says that a defined contribution will save state governments money in the long run, it has to be true, right?
Not exactly.
According to a study by the Teachers’ Retirement System of the State of Illinois, the largest of the state’s five pension systems, this line of thinking is incorrect.
In the Illinois TRS’s breakdown, it is mentioned that “changeover costs to a new defined contribution plan would be significant,” an additional barrier that many supporters of StudentsFirst likely have not considered.
Even more importantly, the Illinois TRS reports, “In fiscal year 2006, the expense ratio of TRS was about 0.30 percent of assets; the average expense ratio of a private sector “target-date” defined contribution retirement fund was 1.29 percent, or 4.3 times higher.”
Another comparison from FY2004 indicates a similar multiplicative of about 4.7 times.
Asset diversification is also an issue in a move away from defined benefit plans, to their contribution-based counterparts, which “typically do not include real estate and private markets, assets that each earned over 20 percent last year,” according to TRS sources.
Who else is on the blacklist besides Loeb and Third Point?
Here’s the full list:
Anthos Capital
Browfields Capital
Clayton Capital Partners
Cohen, Klingenstein LLC
Court Square Capital Partners
Dimensional Fund Advisors
Donald Smith & Co.
Gilder, Gagnon, Howe & Co.
HPB Associates
Invemed Associates
J. Fitzgibbons LLC
K2 Advisors
Khronos
Kiernan Ventures
KKR & Co.
Pergamon Advisors
SLX Capital Management
Stone-Kaplan Investments
VenRock
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Above the list, the following prompt is given by the AFT:
“Directors, managers, advisers and executives of funds below have contributed to, or sit on the governing board of, an organization that advocates for the replacement of defined benefit plans with defined contribution or cash-balance plans.”
What are the implications?
At Insider Monkey, we track 450-plus of the world’s most elite money managers, which manage an estimated 75-80% of the hedge fund industry’s entire asset base. The AFT’s list not only has the ability to affect visible players such as Dan Loeb and Third Point, but it may also harm the likes of David Tepper’s Appaloosa, Carl Icahn, Steven Cohen, and all 33 funds mentioned here.
If an organization who appears to be potentially on the edge, like the Illinois State Board of Investment, decides to pull out of the funds mentioned on the AFT’s list, it’s quite possible that we’ll see a domino effect, with pension funds like the Ohio Public Employees Retirement System following suit.
The largest hedge fund investor, the Teacher Retirement System of the State of Texas, holds an approximated $10 billion, or about 9% of its assets, in the industry according to data from Pensions & Investments.
We’ll be watching Texas, Ohio and Illinois very closely, and it’s likely that the hedgies mentioned on this list will be too.
For more information on the equity strategies of the funds mentioned above, continue reading here.
