While we wait for further news on the outcome of the recent case brought against Blackstone and KKR by the state of Kentucky in the US, we feel there are already some simple lessons we can take from this landmark case and its potentially global implications.
We should probably have known most of these lessons all along, but the current case has become a warning against complacency.
A huge Wall Street scandal
The Kentucky Attorney General, Daniel Cameron, acting on behalf of the Commonwealth of Kentucky, brought the legal complaint against Blackstone Group, Prisma Capital Partners, KKR & Co., and Pacific Alternative Asset Management Co., as well as former executives, in late July 2020.
The lawsuit alleges the firms misled the state into funnelling the retirement funds of the state’s teachers, fire-fighters and other government workers into investments that were “secretive, opaque, illiquid, impossible to properly monitor or accurately value, high-fee, high-risk gambles with no historical record of performance”. The suit asserts these were “absolutely unsuitable investments for a pension fund in the particular situation [Kentucky] was in,” being one of the most underfunded pensions in the US.
Here are three simple lessons we can take from this case now, regardless of the result.
1. Be prepared to react and adapt to market climates
The idea of moving superannuation funds into conservative assets and enjoying comfortable returns has been shattered by falling interest rates in recent years. Added to which, the superannuation industry, like many others, is facing some immense challenges in light of the rapidly developing COVID-19 pandemic.
Prior to the pandemic, low rates have already forced pension fund managers to seek returns in other, more risky asset classes. The crisis and the central banks’ global response now only increase these challenges.
Aside from the obvious impact on asset prices of all kinds, perhaps the most significant short-term impacts will be a need for funds to proactively monitor and manage divergences from their strategic asset allocation bands, consider out-of-cycle asset revaluations for non-listed investments, and seek additional liquidity (or at least understand their liquidity position and risk profile in more detail).
The lessons of the 2008/09 GFC would suggest that investors won’t foresee every hurdle coming their way in their existing portfolios. However, they can prepare themselves to react quickly and constructively as issues develop in their portfolio of private market assets.
2. The need for transparency is clear
Transparency within hedge funds like the Kentucky Retirement Scheme (KRS) and other superannuation funds has always been an issue, but as lawsuits like this begin to make headway, it’s becoming more and more of a necessity.
Understandably, if a manager runs a proprietary methodology that adds value, why should the portfolio holdings be known, when sharing this information runs the risk of someone figuring out the strategy and eating up some of the alpha?
On the other hand, is the request for transparency not a reasonable one, in light of hedge fund managers’ responsibilities for managing such a sizable portion of wealth? Particularly given how difficult it is to monitor whether they are diverging from their stated strategy, using derivatives or leverage inappropriately, or engaging in other unacceptable behaviour.
A 2010 study found that “investors are especially dissatisfied with the quality of information on liquidity and operational risk exposure” from their managers.
At the very least, transparency allows investors to become more aware of investment risks and benefits before they commit themselves. From a fund manager’s viewpoint, transparency can have its advantages too. The process of disclosing data to fund investors can be an important communication tool: Managers can use them as a means to educate their investors, as well as build trust and credibility.
3. Research and an independent opinion can make all the difference
While it was unique that it was the Kentucky Attorney General, Daniel Cameron, who brought the allegations to Blackstone and KKR, it’s not the first time hedge fund managers have been sued for failure to meet promised returns.
This legal complaint was actually a revival of one brought against Blackstone and KKR in 2011 by eight retired beneficiaries. The Arkansas Teacher Retirement System brought similar complaints against investment and insurance giant Allianz for allegedly losing $774 million of the pension’s money in its volatility-trading funds.
So with the current financial climate still in the chokehold of low rates and the effects of the pandemic, and the debate still raging around transparency and disclosure, perhaps the biggest lesson we can learn from this case, and others like it, is the value of independent research and advice.
Stringent quantitative and qualitative investment fund research, conducted by those without vested interests in the outcome, will highlight patterns and help inform unbiased opinions that can help determine the best courses to take before making any investment.
Research IP delivers high quality investment fund research and consultancy services to financial advisers and the broader financial services industry. Our experience spans well over 20 years working directly across the multiple facets of finance, so we understand the key drivers and challenges for managers, as well as the impact for investors and the broader industry.
We strive to give you the best information, so you can help your clients make better decisions, and feel more confident about doing business with you. We believe that not only can everybody win, everybody should.
Reach out to us today about your research and consulting needs, and how to make the data work for you, and your clients.
Photo credit: Bill Oxford on Unsplash
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