Fact Check: The County Pension System's Defense of Its Risky Strategy
News stories earlier this month sparked claims that San Diego County’s pension system is embarking on a risky new investment strategy. Brian White, the pension system’s CEO, shot back, defending the strategy as “the opposite of gambling.”
Statement: The San Diego County pension fund’s “investment strategy is purposely designed to be no riskier than traditional pension fund asset allocation strategies,” SDCERA CEO Brian White wrote in an Aug. 15 op-ed in U-T San Diego.
Analysis: Local and national news stories earlier this month sparked claims that San Diego County’s pension fund is embarking on a new and potentially risky investment strategy.
The stories painted the pension system, known as SDCERA, as a fish out of water and “one of the most extreme examples yet” of a public pension fund to use leverage – generally considered a more risky type of investment tool – to improve its overall performance.
In both letters, he basically repeated the same statement: “SDCERA’s investment strategy is purposely designed to be no riskier than traditional pension fund asset allocation strategies.”
I decided to look into how risky SDCERA’s investment strategy is.
By two important metrics used to evaluate risk in pension funds, White is wrong and SDCERA’s investment strategy is riskier than the norm. SDCERA is taking on significantly more exposure to the market than many other funds and much more than it used as recently as last year. And SDCERA is using what’s generally considered a higher-risk investment tool in a larger share of their fund than others.
Let’s first look at SDCERA’s potential exposure to the market (this means how much money SDCERA has invested in the market versus how much money SDCERA actually has in the bank).
Pension funds can invest more than they have in assets, and one way they can do that is with something called leverage. Although leverage can be a type of borrowing, a fund does not have to directly borrow cash from somewhere else to leverage, or increase its investment. While it is not inherently bad, investments using leverage tactics are generally considered to be more risky than other, more traditional ones.
Last year, SDCERA had an overall market exposure of 135 percent. That means for every $1 they actually had in hand, they had $1.35 invested in the market.
In April, SDCERA’s board decided to give the fund’s investment manager the authority to go even higher and that was the decision that’s attracted all the attention. Now, SDCERA could potentially have a market exposure of 195 percent of its assets, fund spokesman Dan Flores said.
That means SDCERA could have almost $20 billion invested in the market even though it only has $10 billion in assets.
Should the market plummet or SDCERA make too many wrong bets, it could mean deep losses to the fund – something taxpayers would eventually have to cover.
Compare SDCERA’s market exposure with other funds.
The city of San Diego’s pension fund, SDCERS, doesn’t use leverage and only invests the money it has, said spokeswoman Christina Di Leva. CalSTRS, the state teachers’ pension fund, only has 103 percent exposure, meaning for every dollar they have in hand they have $1.03 in the market.
The state pension fund for Wisconsin was one of the first major public funds to use leverage, according to the Wall Street Journal.
That fund has only 106 percent market exposure, a spokeswoman said.
By another measure, SDCERA is also taking on more risk than many comparable funds.
The agency says it will confine the use of leverage strategies to 25 percent of its total portfolio of investments, but that’s already way ahead of its peers.
Again, the city’s pension fund doesn’t use leverage, so its percentage of that kind of investment is zero; the Wisconsin pension fund’s leverage percentage is roughly 6 percent with the ability to go up to 20 percent.
Many experts also agree that SDCERA’s overall approach is riskier than the norm. One financial adviser I talked with last week called it “having a seatbelt in your car and not wearing it.” Even Luis Maizel of LM Wealth Advisors, who was more sympathetic than others to SDCERA’s strategy, told me it was “a little more boom-or-bust than is traditional.”
SDCERA’s argument that its investment strategy is no more risky when compared with other funds relies on the fact it’s using other metrics to evaluate risk. These metrics are widely accepted in the field and useful when trying to determine the overall risk to a fund, but they are only a few indicators of many and can be misleading when presented on their own.
One of the metrics SDCERA points to is the Sharpe Ratio.
The Sharpe Ratio measures what’s known as the risk-adjusted performance of a fund and is recognized by many in the field as one of many useful indicators of volatility.
Before SDCERA voted on the new policy in April, the Sharpe Ratio of its fund was 0.53 compared with 0.45 for average pensions (a higher Sharpe Ratio means a better risk-adjusted performance). Under the new policy and project, the Sharpe Ratio increases even more, to 0.56.
That’s even better than funds like SDCERS, which has a Sharpe Ratio of 0.302.
SDCERA also points to indicators like Standard Deviation (where it also has a strong measure compared with SDCERS and the Wisconsin fund) and Tail Risk that it argues shows it is right there in the mix – or even better – with other funds when it comes to risk. SDCERA also says the probability of everything going bust while it has that much exposure in the market is low.
SDCERA says recent news coverage about its plan has been alarmist and does not take many important factors into account.
“The strategy is structured in such a way so that each component of the portfolio matters however, no individual component matters too much,” Flores said in an email.
All of that may be true. But it’s clear that SDCERA is also embarking on something that includes more risk than the norm. The agency’s money managers now have the potential to invest almost twice the amount of money in the market than it has. And it now has the potential to use an investment tool generally considered to be more risky on at least a quarter of its entire fund.
By both metrics, SDCERA’s investment strategy ranks as riskier than many other local and national public pension funds.
Before I get to a rating, I want to make one thing absolutely clear. Just because an investment strategy is risky, or its money managers are employing strategies that are popularly believed to be more risky, that does not inherently mean it is unwise.
But that’s not what we’re checking. White said SDCERA’s investment strategy is “purposely designed to be no riskier” than other traditional pension funds. By at least two important indicators, that’s not the case. White’s statement is misleading.