Hedge Fund Got Most South Carolina Fees While Lagging on Returns

Mariner Investment Group LLC, a hedge fund founded by a former Bear Stearns Cos. fixed-income executive, charged South Carolina’s pension fund more than any other manager while delivering returns that trailed competitors.

Mariner, started by William Michaelcheck, 65, got $38 million in fees from the South Carolina Retirement Systems in fiscal 2011, or 16 percent of all the compensation paid to the fund’s money managers, which totaled $239 million, according to pension officials.

The performance of Mariner’s investments for South Carolina lagged behind those of managers such as Bridgewater Associates LP, the world’s biggest hedge fund by assets. Mariner funds returned from 2 percent to 13 percent last year, while Bridgewater’s delivered 17 percent to 24 percent. Bridgewater collected $25 million in fees, or 34 percent less than Mariner, while managing $1.3 billion in assets compared with Mariner’s $930 million.

“We take the risk and we pay the fees, but we don’t get the reward,” said South Carolina Treasurer Curtis Loftis, a Republican who was elected in 2010 with Tea Party endorsements and owns a pest control company. “I think it’s systemic. I think it’s happening all across the country.”

Public pensions, seeking to boost returns and reduce volatility after a financial crisis decimated global stock markets, have increased assets allocated to alternative investments such as hedge funds and private equity. Fees for those investments are higher than for traditional stock and bond funds, and returns sometimes trail the 8 percent average yearly gains officials set as their benchmark to pay the rising costs of pensions for public employees.

Alternative Assets Rise

The $26.2 billion South Carolina pension fund, which raised its holdings of alternative assets to about 40 percent of its portfolio in fiscal 2011 from nothing in 2007, is reevaluating the costs it incurs and demanding a better accounting of expenses, Loftis said.

Mariner’s contracts with the South Carolina pension “have recently been renegotiated to ensure alignments of interest and a fee structure commensurate with the desired risk and return profile of the investments,” Adam Jordan, chief of staff for the state’s investment commission, said in an e-mailed response to questions.

Texas’s Permanent School Fund, an endowment established in 1854 to benefit public education, may hire in-house money managers because returns are being “eaten alive” by hedge-fund fees, its chief investment officer said in January.

Beat the Market

Earlier this month, Joseph Dear, the investment chief of the $227.2 billion California Public Employees’ Retirement System, the biggest U.S. pension, said he wasn’t willing to pay hedge-fund managers the standard 2 percent fee, plus 20 percent of profits, if they don’t beat the market.

“Hedge funds, given their poor performance over the past few years, the fee structures are being called into question,” said Andrew McCollum, a consultant with Greenwich Associates based in Stamford, Connecticut. “Over time, we will achieve equilibrium. I don’t think we’re there yet.”

While total fees have tripled in the past three years, South Carolina’s pension returns have sometimes been lower than those for funds of comparable size.

For the three years ended June 30, 2011, South Carolina’s pension returned 3.1 percent, not including fees, compared with about 3.9 percent for public funds with assets greater than $5 billion, according to the Wilshire Trust Universe Comparison Service.

Hedge Funds

South Carolina’s pension jumped into hedge funds, private equity and other alternative investment strategies under its former chief investment officer, Robert Borden.

Borden said cutting the fund’s allocation to stocks to about 30 percent from about 60 percent made it less risky. On a risk-adjusted basis, South Carolina’s was the best-returning pension fund, he said in a telephone interview.

It’s not fair to judge the pension’s performance based on one snapshot, he said. For the three years ended Dec. 31, 2011, South Carolina’s pension returned 12.1 percent compared with about 10.4 percent for similar public funds, according to Wilshire TUCS.

“When you have periods where the equity market rallies up sharply, anybody who’s got that long exposure experiences good performance,” Borden said. “The portfolio is positioned to be very defensive against equity-market selloffs.”

Multistrategy Approach

Mariner, based in Harrison, New York, about 20 miles northeast of Manhattan, manages $4.7 billion and has a multistrategy approach focused on fixed income and credit arbitrage. The firm, which also manages money for New Mexico’s state investment council, has 180 employees. Michaelcheck didn’t return telephone calls seeking comment.

A lack of transparency regarding the underlying assets held by alternative mangers, and fee arrangements hidden from the public eye, present a danger to retirees and taxpayers, Loftis said. The treasurer said the investment commission has denied requests for records, including a detailed accounting of expenses.

Mariner’s $38 million in fees are equivalent to the average annual pension benefit paid to 2,000 of the South Carolina pension’s retirees.

“You can’t explain this to a non-Wall Street person,” said Loftis, who serves as the state chairman of Mitt Romney’s presidential campaign. “If I’m going to pay a bill, I want to know what I’m paying.”

South Carolina’s financial well-being trails by other measures as well. Compared with a year ago, the state ranked 14th worst in economic health at the end of the fourth quarter among U.S. states and the District of Columbia, according to Bloomberg Economic Evaluation of States data.

Louisiana Chief

Borden, who joined the South Carolina fund in 2006 after serving as the investment chief of the Louisiana State Employees’ Retirement System, was charged with diversifying the Palmetto State’s pension following a November 2006 legal change allowing it to invest in assets other than domestic stocks and bonds.

South Carolina was among the first to set up “strategic partnerships” of $750 million to $1.5 billion with Goldman Sachs Group Inc., Morgan Stanley, TCW Group Inc., and Mariner to deploy capital across asset classes.

The state benefits from the breadth of strategies offered by the firms and the ability to move faster on deals, Borden said. It was also less costly than hiring scores of managers, he said.

Borden resigned in December and now works for Delegate Advisors LLC, a financial adviser based in Chapel Hill, North Carolina.

Strategic Partnerships

South Carolina’s pension has strategic partnerships with a total of seven firms that manage about $6 billion.

In October 2008, South Carolina committed $750 million to Mariner, establishing Mariner/Palmetto State Partners LP. The money was split between strategies such as government bond and mortgage-backed security arbitrage or distressed debt trading.

Each of the underlying hedge funds charges a management fee and a performance fee, according to Mariner’s investment adviser registration with the U.S. Securities and Exchange Commission.

For fiscal 2011, South Carolina’s hedge fund investments with Mariner returned 2.3 percent, including fees, or 2 percentage points less than the HFRX index. Pension money allocated to Mariner high-yield debt funds returned 13 percent, lagging behind similar investments with TCW and Apollo Global Management LLC by 0.8 percentage point and 0.7 percentage point respectively.

South Carolina’s real estate investment with Mariner was behind its benchmark by 6.6 percentage points.

Pays Traders

In addition to management and incentive fees, South Carolina pays Mariner’s traders. In a year in which some traders make money and others lose, the pension still has to pay the winning traders a certain percentage, which isn’t offset by the losing traders, said Allen Gillespie, chairman of the South Carolina Investment Commission.

“Say one guy loses $5 million, so he doesn’t make any performance fee and the other guy makes $5 million, you haven’t made any money but you just had a bunch of fees paid,” Gillespie said. “That’s different from a lot of other firms.”

South Carolina’s investment commission didn’t disclose the fees paid to each of its more than 60 managers in its annual report. A separate comprehensive annual financial report filed by the pension only discloses $69 million in fees paid to 25 funds.

Public Records

Bloomberg News obtained a list of fees paid to mangers under a public records request. The pension denied requests for documents showing the terms of the strategic partnership with Mariner or its gross returns.

Seven firms -- Apollo, Bridgewater, D.E. Shaw & Co., Goldman Sachs, Mariner, Morgan Stanley and Selene Investment Partners -- collected $137.6 million, or 58 percent of total fees paid in fiscal 2011, records show.

Borden, the South Carolina fund’s former investment chief, said benefits of the pension’s alternative investments justify the expense. Alternative-asset managers generated $1 billion above benchmarks over three years, he said.

“We paid more, but we got more,” Borden said.