March 01,2007

Baucus, Grassley Question Hedge Fund Investments for American Workers’ Pension Plans

Senators ask GAO to report on returns, risk for employees’ financial futures

Washington, DC – U.S. Senators Max Baucus (D-Mont.) and Chuck Grassley (R-Iowa) want to
know more about American pension plans’ investments in hedge funds, and whether those
investments pose risks for workers’ retirement security. In a letter to U.S. Comptroller General
David Walker today, the Chairman and Ranking Republican on the Senate Finance Committee
asked the Government Accountability Office (GAO) to investigate the scope of public and private
pension plan investments in hedge funds, and what returns and risks are likely for workers’
retirement funds.

“If the folks running retirement plans don’t have the facts about hedge funds, we’ll end up
with the blind leading the broke,”
Baucus said. “Now is the time for a careful, impartial
assessment of just how many retirement dollars are going into hedge funds, and whether
retirees can expect decent dollars to come back out. We need to know whether hedge funds
are real asset builders or just risky business for retirement.”

“A secure pension needs reliable investments,” Grassley said. “We don’t know enough
about hedge funds to know whether they make a pension plan more secure or more
unsound. Pension security and PBGC solvency require getting a handle on hedge funds.”

The text of the Senators’ letter follows here.

March 1, 2007

The Honorable David M. Walker
Comptroller General of the United States
U.S. Government Accountability Office
441 G Street, NW
Washington, DC 20548

Dear Mr. Walker:

Defined benefit pensions are a vital source of post-employment income for millions of retired
Americans. According to the Department of Labor, America’s pension and retirement savings
system includes over 735,000 plans with assets totaling over $7.5 trillion and covering roughly
125 million participants. Pressures for sufficient pension funding and adequate retirement
savings have led pension plan sponsors to seek new and innovative ways to ensure that adequate resources exist to meet future pension obligations. One way that some employers have sought to increase returns on pension plan investments is to invest in hedge funds.

Although there is no universal definition, hedge funds are generally private investment funds
or pools that trade and invest in various asset classes such as securities, commodities, currency,
and derivatives on behalf of clients. A hedge fund can engage in a wide variety of investment
strategies other than hedging, such as taking both long and short positions, using arbitrage,
buying and selling undervalued securities, trading options or bonds, and investing in almost any
opportunity in any market where it foresees impressive gains at reduced risk. Historically, these
funds have primarily served wealthy individual investors and are viewed by many experts as
offering the potential for above-market returns in exchange for greater risk. Also, hedge fund
investments are generally subject to less regulatory oversight than traditional investments.

Since the returns on hedge fund investments are often uncorrelated with returns on equity
investments, pension funds can, in principle, reduce their overall risk exposure through the
purchase of hedge funds. However if pension funds lack the expertise to evaluate the complex
investment strategies that hedge funds employ, greater risks and losses could result. Sponsors
may then be forced to cover these losses through higher contributions. Until recently, hedge
funds were limited in how much pension plan equity they could receive, but the Pension
Protection Act effectively eliminated such restrictions with regard to governmental pension
assets, raising the prospect of even greater pension asset investment in such funds.

Little is known about the extent to which public and private sector pension systems are
investing in these vehicles or the role of regulators in overseeing such investments. Of particular
concern to the committee is the extent to which under-funded plans sponsored by financially
weak employers may be investing in hedge funds in an attempt to quickly build plan assets,
thereby exposing the plan, plan participants, and potentially PBGC and the taxpayer, to greater
financial risk. Given the committee’s interest in a sound U.S. retirement system, we ask that the
GAO conduct a review of the extent to which both public and private pension plan sponsors are
investing in hedge funds and the potential implications of these investments on the U.S. pension
system. Specifically, we ask that you examine:

o What is known about the extent to which both public and private sector pension plan
sponsors invest in hedge funds?

o How do pension plan sponsors evaluate which hedge fund to invest in (e.g., use of
investment consultants)?

o What mechanisms exist to monitor pension fund asset allocation to ensure their
investment in hedge funds is prudent?

o How do pension funds’ hedge fund investment returns (net of fees) compare to the
pension funds’ net returns in other types of investments (e.g., stocks, bonds and index

o What benefits and risks do hedge fund investments pose to pension funds and their

o What roles do the Department of Labor and other federal agencies play in regulating and
monitoring public and private sector pension plans’ use of hedge fund investments?
If you have any questions, please contact Judy Miller or Dean Zerbe at (202) 224-4515.
Thank you for your assistance.

Sincerely yours,

Max Baucus, Chairman
Charles E. Grassley, Ranking Member

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