Recently, the Oregonian ran an article on Intel’s retirement plan and their use of hedge funds investments. If you didn’t get the chance to read it, the article discusses Intel’s use of hedge funds in its retirement plans and “forcing” company contributions into them.
The author wrote that his “logic board” locked up upon this discovery. (It may be time to upgrade his old AMD Athlon processor—may we suggest an Intel Core i7?)
All good-natured kidding aside… in today’s post on the Cordant blog, we’d like to offer another perspective on the topic.
Where We Agree
We’ll start off by addressing where we are in alignment with the article, since there are a few important points on which we agree with the author.
First, he suggests that employees should be given choices, and quality choices, with their investment options. We absolutely agree with this assertion—however, we actually find Intel to do a great job in this respect. We specialize in working with the employees of Intel, but also have a wealth of experience working with clients employed elsewhere. And there is nothing more frustrating than looking at a 401(k) plan and finding limited quality funds to recommend—something we frequently run across. Options available in the Intel plan, however, not only allow basic U.S. stock and bond exposure, but also real estate, international, emerging market, and small cap stocks—as well as the BrokerageLink account, which opens up options even more dramatically. Moreover, Intel is further addressing this issue, and plans to expand investment options starting in 2015.
Second, we agree on managing investment costs, and that expenses providing no net benefit should be reduced (for example, if you’re paying an additional 1% in fees for an extra 0.5% in incremental returns). One cannot control what returns the markets give, but you can control the investment expenses you pay. And therefore, it merits attention. The vast majority managers of traditional equity and fixed income funds have been shown consistently unable to deliver returns in excess of their fee. Which is why at Cordant, we primarily use low-cost index funds in client accounts for allocations to these areas.
These two points aside, however, we have to disagree with the rest of this one-sided article. The author is essentially making two claims: (1) that Intel employees are being force-fed hedge funds, and (2) that hedge funds are bad.
Let’s take a closer look at these two points.
Where We Disagree
Intel employees are being force-fed hedge funds
In the article, the author suggests that Intel is “forcing and locking employer contributions in [hedge] funds.” We think this statement is misleading for a few reasons:
1. The Retirement Contribution account is separate from the 401(k).
Like most other firms, Intel offers a 401(k) account for all employees—providing the opportunity to save pre-tax money for retirement. This account has many low cost index funds available.
The Retirement Contribution account—which is in addition to the traditional 401(k)—is where Intel adds its own funds. The only account that requires a hedge fund investment today is the Retirement Contribution account for employees under 50 years old. For employees under 50, this account is restricted to the Global Diversified fund, which allocates 25% to a diversified hedge fund investment. While hedge funds can be owned in the other Intel retirement accounts (via the Target Date, Global Diversified Fund, and as a standalone option in the SERPLUS account) it is not required. There are many additional quality, low-cost options available in the 401(k), or BrokerageLink account, and SERPLUS accounts.
2. This account is reinforced by the Minimum Pension Plan.
This is also the account that is linked to Intel Minimum Pension Plan. That means that if the account balance is below what Intel calculates you should need for retirement, the minimum pension kicks in. In other words, Intel is on the hook for poor investment performance. This is a fantastic benefit, and one that is very rare in corporate America today. They’re putting their money where their mouth is with regard to hedge funds—and since Intel will be held accountable for performance, they should be able to invest in a way that they see best.
3. This isn’t unusual.
Furthermore, pension plans using hedge funds is very common. In fact, many of the top pension plans and university endowments across the country rely on them heavily. Recently, the head of CERN’s (the European Organization for Nuclear Research) pension system suggested 100% of the pool should be managed by hedge funds. And closer to home, The Employees Retirement System in Texas just allocated hedge funds across it’s entire portfolio.
Hedge Funds Are Bad
Another bold accusation made in the article is that hedge funds are “expensive, opaque and potentially risky.” It implies that they are, without a doubt, bad investments. We disagree with this claim as well.
1. Hedge funds are designed to reduce risk.
Hedge funds have had their fair share of bad press recently, much which is in regards to their recent performance. This is a fundamentally flawed understanding of what hedge fund portfolios are designed to do.
As the name “hedge” implies, hedge funds (when used in an intelligent, diversified way) are used to reduce risk. While there are certainly some risky individual strategies and managers, when used as part of a diversified portfolio hedge funds can reduce the overall level of volatility. This is why Intel uses 21 different managers, not just one.
2. Comparing hedge funds to stocks is comparing apples to oranges.
This goal of risk reduction is precisely why it’s unfair to compare hedge fund performance to overall stock market performance (which the author does in this article). There is simply a different level of risk (volatility) in these two investments. You wouldn’t expect a bond to earn more than stocks over a long time frame, and similarly you shouldn’t expect hedge funds to outperform stocks.
3. On a risk-adjusted basis, hedge funds have performed well.
With this understanding in place, let’s take a look how Intel hedge funds have performed on a risk-adjusted basis—that is how much have they returned per unit of risk (the higher the better).
As you can see, on a risk-adjusted basis Intel’s hedge fund portfolio has bested the performance of equities over the last five years and since inception. (It’s also outperformed outright since 2007.) As for bonds, the hedge fund portfolio has outperformed over the last 5 years, but trailed since inception. However, bonds have benefitted from a period where rates have fallen from 4.67% in May of 2007 (inception of the fund) to 2.46% today (prices increase as interest rates decline). A similar drop in yields should not be expected to boost returns going forward, and research suggests that the current rate is a good prediction of future returns in fixed income.
Simply put, you cannot expect to earn much from fixed income going forward. Only owning stocks and bonds may not be the best way to diversify over the next ten years.
A Word of Caution
When used properly, hedge funds can provide significant benefit to one’s overall portfolio. However, there are some points of caution before using them:
- Understand – Most hedge fund strategies are complicated and difficult to understand. To make matters worse, a wide number of funds calling themselves “hedge funds” (in name only) have emerged trying to capitalize on the growth in the alternative investment space. Work with a qualified advisor to understand, analyze and combine a variety of managers and strategies that complement each other. Intel relies on one of the most respected consultants in the business to assist them in building their hedge fund portfolio.
- Diversify – Just like holding one individual stock is a risky strategy, so would be holding just one hedge fund manager. Developing a diversified mix of both managers and strategies can help lower risk. (This is why Intel holds 21 different hedge fund investments.)
- Mitigate Taxes – Due to more frequent trading in hedge fund strategies, they tend to be less tax-efficient than equities. We suggest holding hedge fund investments in a tax-deferred account (known as asset location). Intel is doing this, as the funds are in tax-deferred retirement accounts.
The Oregonian article raises some great points—it is important to minimize expenses that provide no benefit, and provide employees with quality investment options in their retirement accounts. However, other claims made by the author are not quite as sound. The only account where a hedge fund investment is required is the one where Intel is providing a backstop. And as for hedge funds themselves? When used in an intelligent and intentional way, data shows they can reduce the overall risk (volatility) and diversify a portfolio—leading to a smoother long-term result.
So to address the author’s recommendation to follow the Intel slogan and “look inside” the retirement funds—We have and we like what we see.
 Yield on the 10-year U.S. Treasury bond as of 9/5/2014.
To learn more about How cordant helps intel employees navigate the wealth management landscape, give us a call at (503) 621 – 9207.
Click here for disclosures regarding information contained in blog postings. Cordant, Inc. is not affiliated, associated or endorsed by Intel.