Kentucky’s public pension system is a long-running, worst-in-the-nation disaster. Even as state workers chip in their fair share, the system suffers from years of chronic underfunding by the state. Seeking higher returns, the program, formally known as Kentucky Retirement Systems, has turned to “alternative investments” such as private equity and hedge funds. But those funds also carry far more risk than traditional investments in stocks and bonds ― and much higher fees.
The year before the state’s Republican governor, Matt Bevin, was elected, the pension system had 25 percent more alternative investments than its peers, 27 percent higher costs and 15 percent lower long-term returns, according to a report prepared for the pension board. As a part-owner of a hedge fund himself, Bevin said in 2015 that he didn’t have a problem with the pension system’s heavy reliance on alternative investments like hedge funds. But he campaigned on promises to improve the system and shore it up for the future.
He hasn’t. Despite the Republican Party being in total control of Kentucky state government for the first time in nearly a century, the actual policy changes Bevin has implemented or overseen have mainly ended up supporting the system’s ruinous status quo. And some legislators are raising concerns that state officials ― potentially including Bevin himself ― could benefit financially from the system.
Maintaining Kentucky’s status quo requires that oversight be finely balanced between people who are deeply invested in the current system and people who have very little idea of what’s going on. Since taking office in December 2015, Bevin has picked a former hedge fund director, a current hedge fund owner and a dermatologist to serve on the board that watches over the pension system. In February 2017, he signed bipartisan legislation that shielded the board from disclosing how much it paid some investment managers and prevented it from opening its contract process to competitive bidding.
Under Bevin’s watch, the pension fund has continued to rely on alternative investments. It makes no sense, some state lawmakers argue, to overpay for risky financial products that rarely outperform the market. The retirements of as many as 350,000 public employees ― including social and mental health workers, university staff and others ― are at stake.
Experts, including legendary investor Warren Buffett, agree. Buffett has long advocated against alternative investments, saying it’s better to focus on simpler options that deliver better returns.
“I’ve talked to huge pension funds, and I’ve taken them through the math, and when I leave, they go out and hire a bunch of consultants and pay them a lot of money,” Buffett said last year. “It’s just unbelievable.”
The potential for corruption is also much greater when funds invest in these types of assets over “plain vanilla stocks and bonds,” said Lynn Stout, a professor of corporate and business law at Cornell University.
But Kentucky continues to transfer tens of millions of taxpayer dollars to hedge fund managers. And the state’s front-line public servants are still wondering if the pension money will be there when they need it.
By the time Bevin took office, Kentucky’s public pension system was among the worst-funded in the nation, according to a 2016 study from S&P Global Ratings. The pensions overseen by Kentucky Retirement Systems had just 37 percent of the money required to pay current and future retirees. The largest of the three funds ― Kentucky Employees Retirement System, which covers virtually all state employees except teachers, legislators, judges and state police ― had only enough money to cover 17 percent of its obligations.
Bevin’s first budget, released in January 2016, proposed a larger-than-required monetary commitment to pensions. The legislature eventually passed a budget that put $1.2 billion toward the troubled system.
The governor’s effort to remake the system really got rolling in April that year, when he fired Thomas Elliott, the chairman of the Kentucky Retirement Systems board of trustees and a former banker. Elliott had been reappointed to a four-year term in 2015 by the previous governor. His firing was meant to give Kentucky “a fresh start and more transparency,” Bevin’s spokeswoman said at the time.
Elliott didn’t go quietly ― he chaired the board’s April meeting despite Bevin’s order removing him. The governor picked a dermatologist to replace Elliott, but that individual never assumed the seat, withdrawing in May after the state attorney general said he lacked the requisite investment experience and that Elliott’s firing had been improper. Bevin showed up at the board’s May meeting with state troopers to physically bar Elliott from acting as chair.
“Bevin’s appointments included two hedge fund managers. One was Neil Ramsey, the owner of Louisville, Kentucky-based hedge fund RQSI Holdings.”
Throughout the turmoil, Kentucky Retirement Systems didn’t just continue to invest in hedge funds ― it intensified its commitment. In May 2016, the board dumped $300 million more into four new hedge funds and increased its investment in another hedge fund, created for Kentucky by KKR Prisma, that itself invests in hedge funds.
The following month, Bevin, whose spokesperson did not respond to multiple requests for comment for this article, announced that he would reorganize the entire board of trustees. By executive order, he expanded the board from 13 to 17 members and named economist John Farris as its chairman. The new structure allowed Bevin to appoint seven board members right away. In response, Elliott and another trustee sued Bevin. That lawsuit is ongoing, and Elliott remains a non-voting member of the board thanks to a court order.
Bevin’s appointments included two hedge fund managers. One was Neil Ramsey, the owner of Louisville, Kentucky-based hedge fund RQSI Holdings.
Ramsey, along with his wife, contributed $4,000 to Bevin’s gubernatorial campaign and $15,000 to his inaugural committee, state records show. He also appears to own two other investment companies, according to Securities and Exchange Commission filings: d.Quant Special Opportunities Fund, which late last year acquired a majority stake in another company called ZAIS Group Holdings.
Neither of those firms is listed on the most recent version of Ramsey’s financial disclosure form, a copy of which HuffPost obtained through an open records request. Ramsey did not respond to multiple requests for comment.
The other new board member was William Cook, a former director and senior portfolio manager at KKR Prisma, the company that created the fund of funds for Kentucky Retirement Systems. Cook, who retired from KKR Prisma in 2015, said he would recuse himself from any investment decisions involving his former company.
This past November, as both Democratic and Republican members of the state legislature called on the pension board to divest from hedge funds, the board abruptly changed course and proposed to cut those investments in half. It would divest from 12 hedge funds altogether, and its investment in the KKR Prisma fund would return to the prior lower level. That decision was finalized in December 2016, but it’s not clear how much headway the pension board has made on the promise.
Overall, big institutional investors like pension funds hold a declining, albeit still large, share of hedge funds’ assets. Some pension systems, such as those in California and New York City, have said they will divest entirely from hedge funds. New York City is just getting started, while California’s investment is down 80 percent since 2014.
Kentucky’s progress is less impressive. As of March 2015, the state’s pension program had 10.6 percent of its $16 billion worth of assets in hedge funds. As of March 2017, that number was 8.4 percent, a large portion of which is still in the KKR Prisma fund.
After the pension board’s drama, the Kentucky state legislature took up a measure, known as Senate Bill 2, that had been a priority for reform-minded Republicans and Democrats for more than two years. Its primary aim was to increase transparency around and reduce the costs of the pension investments.
Past versions of the bill, sponsored by state Sen. Joe Bowen (R), included two significant provisions that would have required Kentucky Retirement Systems to disclose the fees it paid to all investment managers ― including managers of the hedge funds within the KKR Prisma fund ― and would have opened up the process of selecting the firms that oversee the pension program’s investments to a competitive bidding process. Currently, state pension officials hire whomever they want to oversee pension assets, and pay whatever fees they think are fair.
The provision requiring disclosure of all management fees was particularly important, given that the KKR Prisma fund is one of the system’s largest hedge fund investments. Generally, funds of hedge funds are used by individual investors who cannot put money directly into hedge funds. Even for those people, funds of funds are rarely a good deal, because they come with an extra layer of fees that goes to the fund-of-funds manager, on top of the fees paid to the underlying hedge funds.
This structure makes even less sense for an investor, like Kentucky Retirement Systems, that can and does put money directly into hedge funds. Kentucky may have gravitated to the fund of funds because KKR Prisma offered a part-time pension employee as part of the deal. Yet that seems to suggest that the pension program didn’t have the in-house expertise or staffing levels needed to invest in hedge funds, let alone a fund of hedge funds.
Measures to require full fee disclosure and competitive bidding were noticeably absent from this year’s version of SB 2, and an amendment to reinsert them was defeated on the House floor. Instead, the latest bill mandated more granular disclosure of fees (but didn’t cover fees paid to underlying funds), strengthened the requirement that pension board members have investment experience (a provision that likely would have precluded Bevin from appointing a dermatologist), and cemented Bevin’s reworking of the board’s structure. These changes were supported by both parties and passed unanimously in February.
How the two stronger provisions disappeared from the bill “is a mystery,” said state Rep. Jim Wayne (D), who has for years fought for pension reforms, including the divestment of hedge fund investments.
Kentucky Retirement Systems, as it had in the past, opposed full fee transparency and competitive bidding on the grounds that those requirements would make the pension funds less competitive, as investment managers would be less likely to do business with them if their books had to be open.
The overall legislation was “a compromise that I worked out with KRS,” Bowen told HuffPost. He suggested that it will still reduce costs and increase transparency because it requires the board to develop best practices for managing assets and picking contractors, and then get those guidelines approved by the state government’s Finance and Administration Cabinet.
“Secret deals don’t help anybody. We’re taking their assumption that we’re getting a good deal, but it’s a secret. And the performance in the market proves that it has been a bad deal for Kentucky.”
Some Kentucky lawmakers wondered whether Bevin had been involved in the watering down of SB 2, even as they stressed there were no clear links. Given his history in the investment field and the new makeup of the board, “it would not surprise me if he had a hand in that process,” Wayne said.
Bowen said that while he’d discussed parts of the legislation with the governor’s office, he’d heard “nothing contrary” from Bevin about the two provisions that were cut.
Regardless, the removal of those provisions, pension experts said, will be a boon to the Wall Street firms and investment managers that are charged with managing Kentucky’s investments. In 2015 alone, the state paid more than $100 million in investment fees related to its pensions.
“The last minute gutting of SB 2 of competitive bidding and weakening of fiduciary standards I believe was worth in the $10′s of millions for the hedge fund & private equity industries,” Christopher Tobe, a former member of the pension board, said in an email. Tobe wrote Kentucky Fried Pensions, a 2013 book that explores the system’s “culture of cover-up and corruption.”
Kentucky is paying those exorbitant fees even as its hedge fund investments cost it even more money. The KKR Prisma fund had a negative 8 percent return in 2016, helping Kentucky Retirement Systems finish the year with a 0.5 percent loss overall. The stock market, the Lexington Herald-Leader noted, rose an average of 15 percent over the same period. A spokesperson for KKR declined to comment after she was sent detailed questions about the company’s role in Kentucky’s pension system.
Before SB 2 passed, state Rep. James Kay, who has spearheaded Democratic pension reform efforts, introduced an amendment that would have restored the provision requiring the disclosure of fees paid to all investment managers. He doesn’t buy the pension board’s argument against it.
“If they don’t want to do business with us because they don’t want to be transparent, that should be the first sign of trouble,” Kay told HuffPost. “Secret deals don’t help anybody. We’re taking their assumption that we’re getting a good deal, but it’s a secret. And the performance in the market proves that it has been a bad deal for Kentucky.”
Lawmakers have also raised the possibility that Kentucky’s elected and appointed officials ― including Bevin, state legislators and members of the pension board ― could benefit financially from the continued opacity of the hedge fund investments.
If the KKR Prisma fund’s undisclosed investments include any of the hedge funds that officials own or operate, that would be problematic, Kay said on Kentucky’s public television network earlier this month.
Because there’s no transparency, the Kentucky pension system could be investing in hedge funds owned or operated by general assembly members, people on the pension system’s board or even the governor himself, Kay said. “There could be people that could actually vote to enrich themselves on our current retirement board.”
There is no proof that Bevin or any of his associates or appointees are benefiting in such a manner. But the idea that they could isn’t just a hypothetical: Heavy reliance on opaque hedge funds and funds of funds has greased the wheels in the past for pay-to-play scandals in major state pension funds, including California’s and New York’s, said Edward Siedle, a former SEC attorney who now forensically investigates public pension systems.
“It’s a way of creating, potentially, a political daisy chain,” Siedle told HuffPost.
How would that work? In Seidle’s version, the manager of a fund of hedge funds could suggest that the managers of the underlying funds contribute to an elected official’s campaign, causes or business associates. That supportive effort might help the fund-of-funds manager get hired by a public pension system connected to the elected official. Once hired, the fund-of-funds manager could then direct business back to those other managers.
“Everybody’s happy,” Seidle said. “Because of the lack of transparency, it’s hard to tell. But ... the potential for personal profit is enormous.”
Questions about Bevin’s pension moves have intensified in recent months, as one of his appointments began to draw scrutiny thanks to a mansion in a posh Louisville suburb.
In March, the Louisville Courier-Journal reported that Bevin appeared to be living in a restored mansion in Anchorage, one of Kentucky’s wealthiest cities. The home had recently been sold by Anchorage LLC to another entity called Anchorage Place LLC. The owners of Anchorage Place LLC aren’t listed on public documents, but Bevin admitted in May that he owns the entity.
Anchorage LLC, meanwhile, is owned by Neil Ramsey, the hedge fund manager Bevin had appointed to the pension board eight months prior. And it appeared the mansion had been sold at a discounted price.
Last year, the Courier-Journal reported, the Jefferson County property valuation administrator assessed the mansion and the 19-acre property on which it sat at nearly $3 million. The sale to Anchorage Place LLC included the mansion and 10 of those acres ― property that was altogether worth $2.57 million, according to the Courier-Journal. The sale price, however, was just $1.6 million ― a reduction of $970,000.
“This is one of the worst cases of personal enrichment by a governor.”
The house wasn’t Ramsey’s only financial connection to Bevin. In May, the Courier-Journal reported that Ramsey had also invested $300,000 in Neuronetrix, a Louisville-based medical device company with ties to Bevin. That investment occurred in February ― at the same time the legislature was considering SB 2 and right as Bevin began living in the Anchorage house. The governor owns at least 5 percent of Neuronetrix and sits on its board of directors, according to the paper.
The Neuronetrix investment qualified Ramsey for a significant tax break. Selling the mansion at a potential loss did too.
During the two months after the mansion’s sale, Bevin “largely ignored” questions about it, according to the Courier-Journal. He told the Herald-Leader that where he lived was not a matter of public interest.
The governor called Courier-Journal reporter Tom Loftus, who led the paper’s mansion coverage, “Peeping Tom” and dismissed reporters who questioned his purchase of the house as “cicadas.” The state’s two largest newspapers, he said, “don’t actually seem to care about Kentucky.”
Ramsey has maintained that he sold the house at fair market value. Bevin similarly batted down questions about the price during a late-May news conference in which he finally admitted he had bought the mansion. “It is arguably not even worth what was paid for it,” he said, “let alone what it’s being assessed at.” Bevin has even appealed the assessment.
But his non-answers have not put the issue to rest. The governor is facing two separate ethics complaints around his acquisition of the mansion. Attorney General Andy Beshear (D), the son of Bevin’s predecessor and a potential gubernatorial candidate in 2019, has asked the state’s Executive Branch Ethics Commission if his office is the appropriate venue to investigate the sale and whether Bevin and Ramsey violated state ethics laws by personally benefiting from it.
“This is one of the worst cases of personal enrichment by a governor,” Beshear said in May. “News reports suggest he is personally enriching himself and his friends, getting a Louisville mansion at half the price from a state contractor, donor and political appointee. ... Because the governor refuses to be direct and honest, someone must investigate.”
Bevin continues to dismiss his critics. In that May news conference, he tied the mansion and Ramsey’s involvement back to the pension crisis that he says he is still trying to fix.
“People that are making the decisions to actually fix the pension system,” Bevin told reporters, “are the very same people that you’re trying to destroy.”
(Disclosure: Travis Waldron interned on the summer of 2009 for the Senate primary campaign of Jack Conway, who ran as the Democratic candidate for governor in 2015 against Bevin.)