With the presidential election campaign machinery reminding Americans that Mitt Romney has money invested in private equity funds registered in the Cayman Islands, little attention has been given to regular Americans having part of their savings invested in Cayman through state pension funds or university endowments.
When Donna Brazile warned in May, as a guest speaker at the Society of Trust and Estate Practitioners’ Caribbean Conference, Cayman would be a topic of more negative ads in the presidential election campaign, she did not exactly require prophetic abilities.
Brazile, who directed former Democratic Vice President Al Gore’s 2000 presidential campaign, said “the American people are not against offshore wealth, offshore ‘tax havens’, but they’re often told that, you know, this is taking something away from them”.
It is no surprise therefore that Republican presidential candidate Mitt Romney’s investments with funds of his former venture capital firm Bain Capital in the Cayman Islands have been in the spotlight ever since.
The latest campaign ad President by Barack Obama rhetorically asked “Why would Romney invest millions in the Cayman Islands?”, insinuating the investment is part of an elaborate scheme to cheat on his taxes.
The answer comes in the form of a quote from Sen. Charles Grassley (R., Iowa) stating “The only real difference that I hear between investing in Cayman Islands or investing in the United States, or the only way that the Cayman Island investments are superior, is the possibility of avoiding US tax. I don’t think that that is something the American public would agree with or appreciate.”
Fox News meanwhile cries foul saying that White House Senior Adviser Valerie Jarrett has up to a quarter million dollar line of credit in Bermuda and DNC Chairwoman Debbie Wasserman Schultz has investments in Swiss bank accounts, foreign drug companies and the Bank of India. Apparently this means that Fox News regards investments by Americans made in foreign countries as unpatriotic.
The New York Times in turn comments on a statement made by Senator Lindsey Graham, Republican of South Carolina that “it’s really American to avoid paying taxes, legally” by stating: “Invest in the Cayman Islands, Mr. Graham seems to be saying. It’s the patriotic thing to do.”
Patriotism may have nothing to do with it but the desire to achieve decent returns on investment most definitely has. It also has led many US pension funds and university endowments to increase their allocations in hedge funds, private equity funds and other so-called alternative investments, with a fair share of them being located in the Cayman Islands.
A survey commissioned by KPMG and the Alternative Investment Management Association covered in this edition of the Journal notes that the majority of capital invested in hedge funds, for a long time only an investment opportunity for the wealthy, comes from institutional investors. Seventy-six per cent of funds reported an increase in capital allocations from pension funds. Meanwhile most capital inflows since 2008 into the industry have come from North America.
US pension funds are under enormous pressure to maintain their projected rate of return. If the California Public Employees’ Retirement System CalPERS, America’s largest state pension fund, for instance had to reduce its projected return by 1 per cent from 7.75 per cent to 6.75 per cent, it would require member contributions to increase by 10 percentage points of payroll, eg from 20 per cent to 30 per cent of payroll, Pensions and Investments reported. Many pension funds are therefore trying to maintain their return by investing in hedge funds.
Like other pension funds the Employees Retirement System of Texas has determined that investing in hedge funds would enhance the characteristics of its investment portfolio by preserving capital, enhancing risk-adjusted returns, diversifying the portfolio and reducing its volatility.
A study by Cliffwater LLC showed that US state pension plans with higher allocations to alternative investments experienced higher 10-year returns than those with less exposure.
The report “Trends in State Pension Asset Allocation and Performance” noted the $7.8 billion Missouri State Employees’ Retirement System, was the best-performing state pension plan for the 10-year period which ended 30 June studied by Cliffwater. It had an annualised 7.1 per cent return. Nine out of the top 10 funds had allocations to alternative investments of 24 per cent or higher and above-average allocations to alternatives played a key role in all but one of the funds achieving strong 10 year returns, the report said.
Given that most of the world’s hedge funds, estimates range between 30 and 60 per cent, are registered in the Cayman Islands, it is not unlikely that a good portion of hedge fund money in the Cayman Islands is coming from US investors, including school teachers, police officers and civil servants through public pension plans.
Indeed, US state pension funds like the CalPERS invest some of their assets in hedge funds in the Cayman Islands. A review of the performance of the CalPERS’ external manager hedge fund allocations reveals several funds that are registered in the Cayman Islands. The Pennsylvania State Employees Retirement System is invested in two private equity funds registered in the Cayman Islands.
The New York State and Local Retirement System had $1.65 billion invested in Cayman in 2011 and the State of New Jersey Pension Fund had $1.18 billion invested with hedge funds in Cayman.
The reason for investing in a Cayman hedge fund is based on risk-return considerations rather than the location of the fund.
Hedge funds and private equity funds are often located in Cayman to enable foreign investors and tax-exempt organisations such as universities and pension funds to invest without onerous US tax complications.
This is also the explanation that Mitt Romney gave. “The so-called offshore account in the Cayman Islands…is an account established by a US firm to allow foreign investors to invest in US enterprises and not be subject to taxes outside of their own jurisdiction,” he said in an interview with the National Review. Even though accurate it is doubtful that this message is going to penetrate the fog of presidential election campaign soundbites.