A Hedge Fund Guaranteeing 12 Percent Returns?
In 2008, three Louisiana public pension plans invested a total of $100 million in the FIA Leveraged Fund, a hedge fund run by Alphonse Fletcher Jr. with about $500 million in assets under management. The appealing part of the fund? It offered to pay the plans a minimum return of 12 percent a year with returns capped at 18 percent.
According to a statement from the pension-fund executives, auditors verified that the pension plan investments accrued the expected return of at least 12 percent since its initial investment. But in March, when two of the pension plans wanted to redeem a total of $32 million from FIA, they were given promissory notes in lieu of cash.
The pension-fund executives had anticipated that a cash redemption would be "accommodated" within a 60-day notice period as initially indicated by Fletcher. However, Fletcher later informed the pensions that a "cash distribution would require an orderly liquidation of assets." The promissory note would allow Fletcher two years to complete the liquidation, at a cost of 5 percent a year.
Fletcher claims that because the fund mostly trades "small, lightly traded public companies," an immediate sale would force the firm to accept less than fair market prices of assets. While this could be true, this can't be verified as auditors have yet to finalize the 2009 results for FIA pending "the valuation of one of the fund's investments."
What can we learn from the pension plans' experiences? There are three key issues at play that you should always keep in mind for your portfolio.
Transparency You should always know what you're holding, or at least, be able to find out quickly. Investments such as hedge funds lack transparency, which causes their investors to lose control over their asset allocation. Without knowing your asset allocation, you can't truly know how much risk is in your portfolio.
Liquidity Hedge funds also lack liquidity and can have significant lockup periods, meaning your assets may be inaccessible at the very moment you need them. The Louisiana pension plans are finding this out the hard way, as their redemption notices have been met with promissory notes instead of cash. Mutual funds, on the other hand, have daily liquidity, so you can get your money if you need it.
No Free Lunches The phrase "too good to be true" especially applies to investing. Guarantees of 12 percent returns simply aren't valid. Any time you are offered such investments, ask yourself: Why are they offering this to me? Do they really like me so much they're going to just hand over such returns? In this case, the risk was that this was a scam in the first place. There are no investments that can guarantee a 12 percent rate of return, and only a fool would invest in something that made that promise. This example demonstrates the truth in Abraham Lincoln's "You can fool some of the people all the time." Unfortunately, it seems likely that the Louisiana tax payers will bear the costs of this foolishness.
Editor's note: Since this article ran, executives from the three pension plans and a principal from the investigative and dispute services department of Ernst & Young investigated Fletcher Asset Management's practices. According to a joint statement, "independent valuations have been used to value the assets in preparing prior audits of the funds in accordance with generally accepted accounting principles. FAM has presented documentation and financial statements indicating that the fund has assets exceeding the value of the systems' investments and earnings showing more than $40 million in profit on the systems' original investment."
Photo courtesy of Steve Snodgrass on Flickr.
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