With the bond market dropping and the bull market slowing, hedge funds and private equity funds are all the rage on Wall Street, and their managers are raking in fortunes. These funds are so unregulated they can get high returns from risky deals unavailable to mutual funds or publicly-traded companies. And with lots of money sloshing around the global economy, those risky deals don't seem all that risky. But what happens when the bottom falls out?
It's one thing if wealthy investors lose the shirts off their backs. They still have plenty of freshly-ironed ones in the closet. In fact, the argument for not regulating hedge funds and private equity funds is that their investors are big enough and tough enough to take care of themselves.
But corporate and government pension plans are increasingly investing in these funds, with money that was previously invested conservatively on behalf of their beneficiaries. Some states are now putting 20 percent or more of public employee pension savings into them. Corporate pension plans, as much as 40 percent of employee savings. But the individuals counting on retirement checks are neither big enough nor tough enough to take care of themselves.
Few if any pension plan managers have any idea of the specific risks they're taking -- because hedge funds and private equity funds don't have to disclose them. And the people whose pensions are at stake -- teachers, policemen, civil servants, and other working Americans -- haven't a clue.
The fact is, there's no free lunch, folks. High rewards coming from high risks are vulnerable to high losses. Diversification is wise, but there's no escaping Newton's Law: What goes up eventually comes down. Even after the fall, hedge and private equity managers will be able to retire with the fortunes they've amassed. But the rest of us may not even get what we're owed. Message to the rest of us: At least call your plan manager and find out how much of your savings are being invested in hedge funds and private equity.
This column is adapted from Reich's weekly commentary on American Public Radio's Marketplace.
