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How Wall Street may threaten your pension

Most people with a pension probably don’t think much about the fees assessed to manage their retirement money. But maybe they should.

Recent reporting by journalists Neil Weinberg and Darrell Preston of Bloomberg reveals that some pensions invest money with private-equity firms and other alternative investment firms that charge unusually high fees, whether the money earns a positive return or not. The funds also require a high degree of secrecy as a condition for investing with them, which runs contrary to basic principles of sound investing. “It is a big concern, because if this money goes into the private-equity firms, it’s not there for the pensioners,” Weinberg tells me in the video above. “Their benefits are at risk.”

Private-equity firms, hedge funds and other alternative asset managers typically cater to sophisticated investors willing to pay high fees for the chance to earn outsized returns. The risks, however, may be higher than with ordinary pools of stocks and bonds. Pensions are typically managed by savvy financial professionals, but some funds may be straining for high returns because they’ve been underfunded by strapped employers putting off the payments they owe their workers for retirement.

Weinberg and Preston scrutinized investments made by the Kentucky Teachers’ Retirement System, which has only about half the money required to make future payouts to retirees. To boost returns and improve its financial prospects, the pension invested at least $1.1 billion with a variety of private-equity firms and hedge funds. Such investments are costly right off the bat: Alternative investment funds typically charge a 2% annual fee, plus 20% of any profit on investments. There can be other fees the investor doesn’t even know about and the fund isn’t required to disclose.

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Weinberg and Preston discovered that fund managers at well-known private-equity operations such as the Carlyle Group and Blackstone determine their own pay and sometimes mingle assets in ways that might be considered a conflict of interest. Many aspects of the way they operate are designated “trade secrets” that can’t be disclosed — terms the pension firms agree to when they sign up.

“If you look into many of these documents, they're not trade secrets,” says Weinberg. “It’s business strategy-type stuff. It has to do with fees, with conflicts of interest. It has to do with some really troubling things.”

Shrewd investors might walk away from such onerous terms. Underfunded pensions, by contrast, may be lured by “velvet-rope syndrome:” the hope that something magical awaits in an exclusive domain they’re not typically privy to. “If you’re underfunded,” says Weinberg, “you automatically want to assume, well, we can expect a 10% return rather than a 7% return. Even though that’s just a guess.”

There’s nothing illegal about pensions paying fees to alternative funds, which in their defense typically say they disclose fees upfront to professional pension managers who ought to know what they’re paying for. And it’s not clear whether any pensions have suffered unusual losses recently from such investments.

But state and federal regulators are looking into the practice and making sure there are adequate safeguards protecting retirees’ pensions. Sounds like something pensioners themselves might want to do.

Rick Newman’s latest book is Liberty for All: A Manifesto for Reclaiming Financial and Political Freedom. Follow him on Twitter: @rickjnewman.

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