Hedge funds are privately-managed pools of capital that invest in stocks and bonds, as well as more unconventional things like derivatives. A lot of pension fund managers like hedge funds because some specialize in zigging when other markets zag. Yale University's pension fund famously beat the S&P 500 by several percentage points over the past decade, in part by using a hedge-fund strategy.
The trouble with hedge funds is that they charge enormous fees, and are largely unregulated. As the Times article notes, hedge fund managers don't have to disclose much about where they're putting the money, and need not update investors daily on what their stake is worth.
Pension fund managers are pretty savvy investors. I doubt we'll see many, if any, big busts out of this trend. I wouldn't be surprised, however, to see teachers, police officers and state employees start asking: um, what exactly is a hedge fund? Where on earth is my retirement being invested? These are fair questions to ask.
The same points came up as pension funds began investing in venture capital, another secretive industry. CalPERS eventually came up with a policy for disclosing returns--even though the mere thought of such disclosure made many venture capitalists bristle.
It would ironic if a similar debate erupts over hedge funds. Ultimately, the question may not be whether the public sector should invest in hedge funds. It may be whether hedge fund managers will put up with the hassles of doing deals with government.
