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F I S C A L I M P A C T R E P O R T

SPONSOR Zanetti

ORIGINAL DATE

LAST UPDATED

1/24/08

HB 413

SHORT TITLE Prohibit State Investment in Hedge Funds

SB

ANALYST Francis

REVENUE (dollars in thousands)

Estimated Revenue

Recurring

or Non-Rec

Fund

Affected

FY08

FY09

FY10

* See narrative

(Parenthesis ( ) Indicate Revenue Decreases)

Relates to SB150

SOURCES OF INFORMATION

LFC Files

Responses Received From

State Investment Council

SUMMARY

Synopsis of Bill

House Bill 413 would prohibit the investment of state investment council managed assets in a

hedge fund. “Hedge fund" is defined as a private investment fund or pool, including a relative

value fund, market neutral fund, arbitrage fund, or long or short equity fund, the assets of which

are managed by a professional management firm that trades or invests through public or private

markets in securities, commodities, currency, derivatives or similar classes of financial assets or

is not an investment company pursuant to the 15 U.S.C. 80a-3(c)(1) and 15 U.S.C. 80a-3(c)(7)

(defined below).

The prohibition would take effect on July 1, 2008.

FISCAL IMPLICATIONS

The fiscal implications are significant but difficult to calculate. As of 12/31/07, the SIC had total

assets under management of $16.1 billion, including $1.48 billion in its “Absolute Return" asset

pool. The Absolute Return pool is the asset class that includes hedge funds and makes up 9.2

percent of the portfolio. This asset class returned 8.5 percent in calendar year 2007,

House Bill 413 – Page

2

outperforming a benchmark of the 90-day US Treasury Bill plus 200 basis points which returned

7.3 percent. Over the year, SIC earned $17.8 million more by investing in hedge funds. In

November, 2007, the SIC approved a change to the policy target for this asset class from 10

percent to 15 percent.

SIGNIFICANT ISSUES

According to SIC, the SIC’s hedge fund investments primarily focus on an absolute return and

low volatility strategy overall, intended to neutralize market risk, and produce positive returns in

most market environments. Risk is mitigated via diversification among 13 managers which have

exposures to more than 400 individual hedge funds employing various styles and strategies. The

benchmark for this asset class is pegged at a conservative return goal of T-bills plus 200 basis

points. Put simply, the SIC’s hedge funds are meant to help diversify the Fund, provide

protection during down markets, and achieve returns above what has been an increasingly

challenging investment environment in the fixed income arena.

PERFORMANCE IMPLICATIONS

All of the funds were allowed to diversify when the “legal list," a statutory list of allowed

investments was repealed and replaced with the broader “Prudent Investor" rule which allows

SIC, the Public Employee Retirement Association (PERA), and the Education Retirement Board

(ERB) to invest in a much broader range of investments, including hedge funds, private equity,

and real estate [45-7-601 to 45-7-612 NMSA 1978].

CONFLICT, DUPLICATION, COMPANIONSHIP, RELATIONSHIP

Relates to SB150 which would add an additional member to the Council.

TECHNICAL ISSUES

HB413 would prohibit future investments but existing investments in hedge funds would not

have to be liquidated because the language refers to future decisions not past ones.

According to SIC, HB 413 fails to adequately define hedge fund, as its broad definition of hedge

fund could be construed broadly to include private equity funds as well as several other

alternative investment vehicles, including real estate partnerships. This imprecision could lead to

disruption of ongoing SIC private equity investments, inclusive of those made in New Mexico

companies or venture funds.

OTHER SUBSTANTIVE ISSUES

The bill only refers to SIC and hedge fund investments but the PERA and the ERB also invest in

hedge funds.

The LFC reports quarterly on the investment performance of all funds by asset class and time

period. These reports can be found on the LFC web site at

http://legis.state.nm.us/lcs/lfc/lfcpublications.asp

House Bill 413 – Page

3

WHAT WILL BE THE CONSEQUENCES OF NOT ENACTING THIS BILL

The SIC will continue to invest the state permanent funds according to the Prudent Investor rule.

NF/bb