These days the most talked about pension fund in the US is New Jersey State's Retirement System. With $81bn (€54.7bn) in assets, it is the ninth largest US public pension fund. It is also the instigator of a highly innovative attempt to team with other large institutional investors, including foreign sovereign funds, in order to negotiate lucrative investment deals.

The idea came about in January, when Citigroup and Merrill Lynch were desperately looking for quick new money to cover their losses in the sub-prime mess. To the rescue came not only government-run funds from South Korea, Kuwait and Singapore, but also the New Jersey fund. It invested $400m in Citigroup preferred stock - with a coupon of 7% and a 20% conversion premium - and $300m in Merrill Lynch preferred stock, with a guaranteed 9% coupon for two-and-three quarter years. The grounds for the investment were the "significant current yield and the opportunity to benefit from potential appreciation in the underlying common stock of these firms", according to a statement by the New Jersey Division of Investment.

A few days later, the chairman of the New Jersey State Investment Council, Orin Kramer, added that the fund was in talks with other large investors and foreign government funds about forming a sort of ‘consortium' to drive more favourable terms in future deals.

The move has attracted some criticism, however, because of the not-so-stellar financial shape of New Jersey's pension system, which is one of the worst funded US pension systems, with a deficit of at least $25bn.

According to Doug Forrester, former candidate for governor of New Jersey, the public employee system could be as much as to $175bn in the red because of questionable ‘Enron-type' accounting practices: the state has diverted billions of dollars from its pension fund to other purposes over the last 15 years. It has also recorded investment gains immediately while delaying reporting losses. The fund is currently under investigation by the SEC.

The current governor, Jon Corzine, recently said that painful measures must be taken to address "a state of financial emergency" for New Jersey's government. Those painful measures cannot include cutting benefits for state employees, so the fund must find other ways to solve its financial problems.

Chris McNickle, managing director of Greenwich Associates, identifies two ways. "Either you increase contributions, which in the case of a public pension fund means raising taxes, or you try to get strong investment returns. The second strategy has been embraced by a new team of managers who started working at the New Jersey fund some years ago. They have diversified more in favour of alternative investments.

Purchasing a stake of Citigroup and Merrill Lynch is perfectly consistent with their new strategy and the trend that has been on-going among pension funds for some years now, that is investing in private equity, hedge funds and the like."

McNickle points out that $700m is less than 1% of New Jersey's total assets so it makes sense as an appropriate diversification. "There is always the risk that when a fund is controlled by political bodies and it places a large bet, the decision is made for political reasons," admits McNickle. "But this time it looks like the implementation of an investment strategy."

"I don't think the New Jersey'spension fund made a political decision, I believe the investment committee saw undervalued assets and bought them seeking alpha and cutting the middle man," agrees DJ Lucey, senior analyst with Cerulli Associates.

Mark Ruloff, director of asset allocation at Watson Wyatt, stresses the peculiarities of New Jersey's pension fund. "It has a structure and management that allow making such investments and then monitoring them."

Ruloff suspects that there may be some political component in New Jersey's decision to invest in Citigroup and Merrill Lynch, given that so many employees of the two banks live in that state. "However that means assuming more risks," says Ruloff, "because if the two banks get into more serious troubles and fire people, the state loses both investment returns and taxpayers."

New Jersey State's Retirement System declined IPE's request for an interview.

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