By Dan McSwain
Warren Buffett famously quipped that you can’t tell who is swimming naked until the tide goes out.
Well, the waters supporting San Diego County’s pension fund have been receding lately, siphoned by losses in bond, commodity and foreign markets.
Now one of the officials charged with protecting the investments of taxpayers and retirees is taking a hard look at the fund’s exotic, supposedly low-risk investment strategy.
Last month County Supervisor Dianne Jacob, who serves on the pension fund’s board, told investment officials that she was concerned about how the fund’s Treasury bond portfolio was being managed in the wake of heavy losses in May and June. And she asked for a thorough review of the fund’s use of leverage.
Ordinarily, Jacob’s alarm over short-term losses would send me into a tizzy. Overreaction to market fluctuations is precisely why individual investors — and most fund managers — tend to sell at the bottom and buy near a market top.
Yet in this case I’m delighted. Sticking to your guns is admirable only if you have the right investment strategy and a skilled practitioner.
But San Diego County’s pension board has chosen a strategy that is expensive and far riskier than advertised.
It’s possible that the architect of this strategy, consultant Lee Partridge, is in fact a skilled practitioner. Or he may have been lucky.
Since the board hired him in October 2009, the fund’s investments have grown in value at an average annual rate of 9.3 percent.
Although that lags the performance of the S&P 500 stock index since then, it’s better than the average traditional pension fund with a portfolio of 60 percent in blue-chip U.S. stocks and 40 percent in top-rated bonds. It also beats some benchmarks that seek to simulate a broadly diversified portfolio.
However, it’s also possible that the county’s luck has turned, highlighting the inherent vulnerabilities of Partridge’s particular approach to diversification.
Partridge reported this month that he substantially underperformed his peers in the fiscal year that ended June 30, as bad bets on bonds, commodities and foreign securities produced losses in recent months that cut into previous gains from investments in U.S. companies and real estate.
Overall, San Diego County’s portfolio grew in value by 7.8 percent during the year, compared to an average of nearly 13 percent in a peer group. The fund for San Diego city workers grew by 13.4 percent. Sonoma County’s fund gained 15.3 percent.
Yet the news for local taxpayers gets worse.
The county fund pays about $7.2 million a year to Partridge and his firm, Salient Partners. Tens of millions more go to fund managers picked by Partridge.
Meanwhile, the investment strategist for San Diego’s city pension system makes under $200,000 a year. Although additional city employees do some of the work that is done for the county by Salient, I’d be surprised if the annual staff cost is more than a tenth of $7.2 million.
The members of the county’s pension board are no dummies. So why are they paying so much for fund management? I fear the answer boils down to hubris, along with a strange susceptibility to investing fads.
For years county pension officials have prided themselves on their investing skills, using terms like "innovative" and "cutting edge." Then the Panic of 2008 hammered the fund with paper losses as values fell among stocks, real estate, hedge funds and other investments.
But instead of being humbled by the experience, board members doubled down.
They hired Partridge, a bond trader by experience who was relatively unknown in the small universe of pension advisers and had never run a large public fund.
But he was touting an investing strategy he has variously called "partial risk parity" or "risk allocation." The strategy was popularized by Bridgewater Associates, the giant manager whose All Weather hedge fund performed well during the 2000s, when stock markets crashed twice.
The strategy promises the Holy Grail of investing; market-beating returns at reduced risk.
It has several problems. The most serious is that the pitch just isn’t true.
Partridge’s strategy, which involves exotic bets on bonds, commodities and foreign securities, is incredibly risky.
Like Jacob, I’m particularly worried about his use of leverage. At present the fund uses derivatives and swaps, mostly in bets on U.S. Treasury prices, to control 35 percent more in securities than the county portfolio’s total assets.
If those bets go south, Partridge must deplete the fund’s cash holdings or liquidate hard securities. This isn’t investing; it’s speculating, pure and simple.
And Partridge has openly discussed raising that leverage ratio from 35 percent to an astonishing 137.5 percent. For better and worse, the fund’s $9 billion would behave like a $21 billion diversified portfolio — supposedly with less risk — by reducing the proportion of blue-chip U.S. stocks and instead betting billions on Treasuries, foreign bonds, commodities, real estate and hedge funds.
With any luck, a new fad is taking shape in the investing industry.
The Wall Street Journal reports that pension managers in Montgomery County, Pa., concerned about high fees and lousy performance, are moving their assets into funds offered by Vanguard Group Inc. These passively managed funds charge rock-bottom fees and simply match the performance of various market indexes.
Montgomery made the move after seeking the advice of Jack Bogle, the retired Vanguard CEO who pioneered index funds after research showed that the overwhelming majority of the hotshots who manage hedge funds, mutual funds and other "actively managed" portfolios routinely underperform stock and bond indexes.
Bogle understood that the primary goal on Wall Street was to maximize fees.
They may be boring, but index funds have saved clients billions over decades in lower fees and improved performance.
Clearly, some of the cool kids on Wall Street are using derivatives to trade in and out of U.S. Treasuries and Brazilian copper mines.
But the county’s pension board is speculating with money that belongs to taxpayers and retired government workers. That isn’t cool at all.
Source: U-T San Diego
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