Detroit Inches Closer to Solvency as Pension Creditors Drop Objections

The last of Detroit’s major pension debt holders settled their objections to the city’s solvency plan in the eleventh hour, as the city made its final arguments to end bankruptcy.

“The end really is in sight,” said Bruce Bennett, Detroit’s lead attorney. “This plan is very broadly consensual at this point and the city has settled with all the objectors and all the major economic players in the city of Detroit.”

Investors including hedge fund managers Aurelius Capital Management and bond insurer Financial Guaranty Insurance Company were owed $1 billion by the retirement system. If the city’s plan is passed, the investors will be given $141 million in new notes.

Debt holders had previously argued against Detroit’s pensioners receiving a higher payment.

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According to the city’s updated plan filed in April, current retirees would see their pensions cut by 4.5% and future pensioners could see as much as a 20% reduction. Cost of living adjustments would also be trimmed from benefit calculations.

In his closing arguments, Bennett argued for Detroit’s plan to carve $7 billion from its $18 billion in liabilities and reinvest $1.7 billion over 10 years for city services. He also highlighted the number of brokered deals since filing its Chapter 9 bankruptcy on July 18, 2013.

“It’s hard to overstate the significance of the fact that that’s only 15 months and eight days ago,” Bennett said. “We had litigation with everybody about something.”

The plan also includes a “grand bargain” intended to protect the city’s art collection from being sold to pay off debt holders and reduce pension cuts using $816 million from private foundations and Michigan taxpayers.

“It is a reasonable decision for the city to want to keep a world-class art museum in the city as a potential contributor to its future,” Bennett said.

US Bankruptcy Judge Steven Rhodes said he would decide whether the plan is feasible and fair to creditors next week.

Hedge funds have been getting a bad reputation recently but not all criticisms may be deserved, according to AQR Co-founder Cliff Asness.

“One accusation the critics make is ‘just look at 2013’ when hedge funds, mistakenly often assumed to be very aggressive investments, failed miserably to keep up with the S&P 500,” Asness wrote in his most recent article “Hedge Funds: The (Somewhat Tepid) Defense.”

Hedge funds underperforming the roaring stock market in 2013—an overall return of 9.4% versus 32.4% for the S&P 500—is consistent with their low beta and low correlation with equities. Asness said despite critics’ claims, it was only a “mildly disappointing” year for hedge funds.

“Hedge funds are not meant to keep up with the S&P 500 one-for-one, certainly not when it soars,” he said. “Of course some stars will keep up, either by luck or skill, but as a broad category it’s never been the case at such a time.”

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asness hedge fund 1 (Source: AQR)

2008 was also not as bad a year for hedge funds as it looked, Asness argued, as the group is only partially hedged to equity market returns.

Furthermore, when looking at hedge funds’ compound return—annualized over the 1994 to 2014 period—the asset class “looked OK”. It only trailed the 60/40 portfolio by 0.5 percentage points, according to AQR’s calculations.

However, Asness’ defense for hedge funds ends there.

Observing hedge fund beta and correlation to the S&P 500 for a rolling 36-month period, Asness concluded hedge funds have been delivering the “same expensive stock market beta but less of the uncorrelated stuff”—things for which investors pay high fees.

“The ‘uncorrelated stuff’ I refer to may in fact be true manager alpha, but is also composed of many known strategies that, even if they survive hedge funds’ very high fees, should be available to investors at more reasonable fees,” he wrote.

Cumulative alpha from 1994 to 2013 also revealed it had essentially flattened since the financial crisis, supporting Asness’ assertion that hedge funds should be offered at a better price.

asness hedge fund 2 (Source: AQR)