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The County Pension’s Wall Street Game

The county’s pension fund is betting bigger, but officials deny they’re at the casino.

The County of San Diego offers its employees some of the best retirement benefits around, and to pay for them, it has amassed a $10 billion fund.

But it’s not enough money. In recent months pension officials have green-lighted changes to their investment strategy in hopes of boosting the fund’s performance to better ensure it’ll have the cash it needs to pay what’s promised to retirees.

This situation is a lot different than it used to be.

Less than 15 years ago, the county had set aside more than enough money and assets to pay all of the pensions of its workers for their expected life spans. But then the county increased pensions 50 percent retroactively. Suddenly thousands of workers could expect a much better retirement.

Hundreds of them retired almost instantly and then the fund was left with far fewer assets than it needed to fully cover everyone. Officials borrowed $1 billion, invested all of it and then became some of the most aggressive investors in their class.

And then in 2008 the county lost billions and the fund decided to oust the architect of that investment strategy and bring in a new crew.

The bottom line is that in 2001, taxpayers didn’t have to put anything into the pension fund. A decade later, they put in some $325 million. That figure doesn’t include additional money needed to pay back Wall Street after the fund borrowed a handful of times to try to help shore up its balance sheet.

Now, it looks like the county pension fund’s bets are getting bigger.

Meanwhile, a chorus of critics are sounding off on decisions by the fund’s trustees to greatly increase the risk of its investment portfolio. Here’s what you need to know about what’s going on.

The Headlines

On Aug. 9, U-T San Diego columnist Dan McSwain challenged the intelligence of an April decision by the pension board to allow for greater risk in its investments.

The Wall Street Journal followed with a piece soon after explaining that the new strategy “is complicated and potentially risky” even if officials say it is designed to protect against losses in the event of a market meltdown and is not purely being implemented to make up ground.

“San Diego’s approach is one of the most extreme examples yet of a public pension using leverage – including instruments such as derivatives – to boost performance,” the WSJ said.

At the heart of the concern is whether the pension’s money managers and board are being too cavalier in their pursuit of higher returns, and the fear is that they could overexpose the fund and fall hard if more-risky investments do not work out as planned.

The pension fund, which is known as SDCERA, disagrees. It has fought back in a series of written responses to the coverage and op-eds.

“SDCERA’s investment strategy is purposely designed to be no riskier than traditional pension fund asset allocation strategies,” SDCERA CEO Brian White wrote in an op-ed to the U-T.

So What’s the Bet?

The SDCERA board in April voted to give its top money manager and firm more flexibility in where and how they invest their money.

This flexibility allows the investment manager to engage in a variety of strategies known by popular industry buzz words like “trend,” “risk parity” and “leverage.” The Wall Street Journal said this “involves buying futures contracts tied to the performance of stocks, bonds and commodities. That approach allows the fund to experience higher gains – and potentially bigger losses – than it would by owning the assets themselves.”

Members of the pension board are not done with the changes however and are continuing to discuss the strategy.

In a statement released by her office, pension board member and San Diego County Supervisor Dianne Jacob defended her vote in favor of the plan. She said that the strategy that was getting all the attention was only a part of the county’s entire portfolio.

“Our portfolio strategist, our independent consultant, other experts and the entire nine-member SDCERA board all agreed that leverage is not inherently bad or overly risky, and is just one investment tool in the overall investment strategy,” the statement read.

Outsiders, however, said that the county is beyond the norm in how much risk it’s taking on.

Wealth managers like Luis Maizel of LM Capital Group said the strategy is “a little bit more boom-or-bust than is traditional.”

To prove his point, Maizel printed out a copy of the asset allocations of CalSTRS, the state teachers’ retirement investment fund and pushed it in front of me.

CalSTRS’s targets, according to a Sept. 10, 2013, news release, are to have 51 percent of their money in global equity, 16 percent in fixed income, 6 percent in an “inflation sensitive” category, one percent in cash and maybe one-half to one-third of their real estate investments as “traditional.” That leaves the 13 percent they are putting in private equity and maybe four or five percent more from real estate as non-traditional investments.

That means CalSTRS has roughly 17 percent of its money in risky, non-traditional investments. Compare that to SDCERA, which has about 25 percent of its money in these risky investments.

However, Maizel believes that referring to what SDCERA is doing as “gambling” is a bit exaggerated and “a little alarmist.”

But Herb Morgan of Efficient Market Advisors likened SDCERA’s strategy to “having a seatbelt in your car and not wearing it.” He believes the pension fund is playing a dangerous game with taxpayer dollars.

“Risk-parity, it’s not a question of if, it’s a question of when it fails,” Morgan said.

“Instead of trying to slowly, conservatively work my way out of this … the county is taking an entirely different tact and their tact is, let’s bet bigger,” Morgan said. “And as long as I’ve been on Wall Street, betting bigger has not worked out for the guys I know, except for the guys that shorted the housing market.”

And Sean Karafin of the San Diego County Taxpayers Association worries that if the new strategy doesn’t pan out, the public will have to pay.

“If you’re looking for higher returns, you take more risk. That’s what they’re doing, they’re taking more risk,” Karafin said.

“It’s much less conservative than comparable funds,” he said. “Somebody’s going to have to pay and taxpayers are on the hook if things go south.”

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