Steven Drobny, who compares the joy of writing to “putting toothpicks in my eyeballs,” said he was obliged to write his second book because he’s worried taxpayers may one day have to bail out pension plans -- and he blames Harvard’s class of ‘69.
Drobny co-founded Drobny Global Advisors, a Manhattan Beach, California-based research firm dedicated to macro hedge funds, so named because they invest in everything from currencies to commodities based on macroeconomic trends.
He taps his vast and normally reticent network of hedge-fund managers for answers in “The Invisible Hands: Hedge Funds Off the Record -- Rethinking Real Money” (Wiley $29.95). The format will be familiar to readers of Drobny’s first book, “Inside the House of Money” (Wiley, 2006), which detailed trading secrets through interviews with some of the largest hedge-fund managers.
This time the managers, who in aggregate oversee more than $100 billion, were required to have successfully navigated 2008’s market meltdown. Their counterparts at sovereign wealth funds, pension plans and endowments, the so-called “real- money” investors who are the largest investors in the world, by and large did not.
Pension plans in 2008 saw assets fall by 20 percent and U.S. university endowments lost an average of 26 percent, leading to job cuts and halted building plans at even the richest schools such as Harvard University and Yale University.
Drobny livens up the topic with ample explanatory exhibits. One shows U.S. states’ pension-manager pay compared with university football coaches; another is culled from the 1984 film “This Is Spinal Tap.” In a telephone interview from Manhattan Beach, California, Drobny said the risk of getting it wrong again means moving to “Bartertown,” the post-apocalyptic village in “Mad Max Beyond Thunderdome.”
Cahill: Why write this book?
Drobny: I never wanted to write another book, but I capitulated after hearing too many excuses by people running big-money pension plans. The passivity, that “it’s not my fault,” is unacceptable in professional money management.
Cahill: What have these managers learned?
Drobny: I asked one real money chief investment officer, if he had perfect foresight that the fall of ‘08 was going to be as much a debacle as it was, what would he do? His response was “that’s a good question.” That’s not a good question, it’s the only question. And it’s exactly what all institutional investors should be asking.
Cahill: Aren’t these guys hamstrung in what they can do?
Drobny: A lot of it comes down to investment committees they face, the boards, and there may be an element of career-preservation. But argue for your limitations and they’re yours. The battle is already lost when that’s your starting point.
Cahill: What is it about pension managers as a class that explains some of what went wrong?
Drobny: A lot of it is career game theory. If I color outside of the lines I get fired. But if I lose money and everyone else does I’m OK. A significant part of the benchmarking process is driven by consultants. There is a safety and comfort factor in herding.
Cahill: One of the most powerful interviews in the book is with a pension manager who says we get what we pay for. Where does this disdain about paying for investing talent for pensions come from?
Drobny: I almost dedicated the book to the Harvard class of ‘69 who said no one on the endowment investment team should get paid more than the university president. They complained about paying top talent millions and in return the endowment lost billions. That rule, of course, doesn’t hold true when you think about college football coaches. These pension funds have been around for a long time and grown into massive size yet the structure around compensation for managing them hasn’t evolved.
Cahill: The poster boys for real money investing were the Harvard and Yale endowments, which were among the most hurt in 2008. What happened?
Drobny: The whole world piled into the endowment model at precisely the wrong time. The model worked for so long and so many people emulated it that it drove down the illiquidity premium -- highly illiquid assets were priced like highly liquid ones. The liquidity premium was just too low.
Cahill: Have any lessons been learned?
Drobny: Almost all of these plans are talking about raising contribution levels or enacting other measures to plug funding gaps, but no one’s talking about just running better portfolios. Also, no one is talking about taking advantage of the get-out-of-jail-free card they were just issued and protecting the portfolio as they should have been doing in 2007.
Cahill: At one point in the book you say these pension plans are the ultimate too-big-to-fail because taxpayers backstop them. Should we all be afraid?
Drobny: Some of the hedge-fund managers I talk to think the last 30-year period has been an anomaly for assets that have generated relatively decent returns due to falling inflation and falling interest rates. If we are in for a Japanese type scenario, all these pension plans are going to go bust. They have all their risk in equities!
Cahill: Then what?
Drobny: Then we all move to Bartertown.
“The Invisible Hands: Hedge Funds Off the Record -- Rethinking Real Money” is published by Wiley (384 pages, $29.95). To buy this book in North America, click here.