Tax hike won't hurt pensions much

NEW YORK (CNNMoney.com) -- Those who oppose hiking taxes on private equity partnerships and hedge fund managers have been trying to make the case that any increase would end up hurting policemen, firemen, teachers and anyone else with a pension, since pensions are major investors in alternative investment funds.

Their reasoning: Managers of private equity partnerships would likely pass through the tax increase to the pension funds by boosting their fees, which would hurt returns.

But expert witnesses before the Senate Finance Committee on Thursday indicated a tax increase might not have a very big effect, if any at all.

Alan J. Auerbach, an economics and law professor at the University of California, Berkeley, estimated that even if half of the increase were passed along, "This tax burden would imply a reduction of at most around 2 basis points [0.02%] in the annual return on these pension funds' assets - and quite possibly much less."

(The Debate: Are managers of private equity partnerships and hedge funds sufficiently taxed?)

Russell Read, chief investment officer of the California Public Employees' Retirement System (CalPERS), which invests 7 percent of its assets in private equity, said that ever since CalPERS first started investing in private equity in 1990, "There's been no change in [fee] terms as tax rates have shifted." But, he noted, the trend during that time has been toward lower rates on managers' compensation.

"As we go the other way, my personal expectation is that [a hike] would be a factor [in negotiating fees], but just how much is hard to know," Read said. Nevertheless, he added, given the hundreds of private equity partnerships in which CalPERS has a stake and the fact that each partnership fee structure is negotiated separately, he would expect there might be a change in some cases but not in others.

Earlier this week, the National Conference on Public Employee Retirement Systems (NCPERS) informed Senate taxwriters it would not take a stance on the bill, noting that while some of its members believe it could have a negative effect on public pension plans, "the majority of our members do not share that opinion."

The organization asked lawmakers to disregard an August 24 letter NCPERS sent, in which it stated its opposition to the bill, a position apparently based on the minority of NCPERS members who did think a tax increase would adversely affect them.

The third witness at Thursday's hearing, Donald Trone, president of the Foundation for Fiduciary Studies, spent much of his testimony expressing concern over what he considers pension managers' imprudent pursuit of the market-beating returns from private equity and hedge funds.

"In theory, a tax hike would have the effect of making hedge funds and private equity investments less attractive in a prudently diversified portfolio," Trone said. "In reality, the current, unbridled exuberance for these investment strategies means that a tax increase will have little-to-no-effect on their use."