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A Pension Fund Comes to Its Senses

Barry Ritholtz is a Bloomberg View columnist. He founded Ritholtz Wealth Management and was chief executive and director of equity research at FusionIQ, a quantitative research firm. He blogs at the Big Picture and is the author of “Bailout Nation: How Greed and Easy Money Corrupted Wall Street and Shook the World Economy.”
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Last August, we called out the San Diego County retirement fund for paying way too much in fees to Salient Partners, its outside pension-fund manager. Based on reporting by Dan McSwain, the San Diego Union-Tribune alerted readers to a dramatic increase in the use of leverage once Salient took the reins.

On July 16, the county fired Houston-based Salient, according to the Union-Tribune.

Last year's events made for a great local comparison between San Diego County and the City of San Diego. The two local municipal regions each have a separate retirement system for employees.

The county system was highly leveraged, expensive and performed poorly. According to Wilshire Trust Universe Comparison Service, San Diego County's returns ranked in the 84th percentile among public pension funds during the three years to Dec. 31, 2014, and in the 54 percentile for the five-year period.

The county had hired Salient to goose returns; it increased leverage threefold to 100 percent of the assets in the fund. For this high-risk strategy, Salient Partners was paid $8 million a year.

As we noted last year, contrast this with the local competition, the City of San Diego, which had its own pension problems a decade ago. After fraud and conspiracy indictments in 2006, and Securities and Exchange Commission charges in 2008, it cleaned up its act.

The City of San Diego simplified its pension plans. It barred the use of leverage in favor of a low-risk, asset-allocation approach. As we discussed last year, it is reaping the rewards. The city's fund has outperformed the county's, earning about 13.6 percent a year versus Salient's returns of 10.1 percent since it was hired in October 2009 through June 2014. That's before fees; the city's net returns with its lower cost-basis, look even better after fees.

By contrast, San Diego County spent $103.7 million in investment and administrative fees in 2013. The $10 billion pension fund is one of the highest-cost plans in the country as a percentage of assets.

In April 2014, pension board members voted unanimously to approve the highly leveraged-investment strategy. Raising risk to increase gains seems contra-indicated for long-term investors who won't have access to their funds for decades.

Pension fund directors Dianne Jacob and Samantha Begovich first proposed ending the arrangement 10 months ago but couldn't win a majority vote of fellow board members to bring fund management back to in-house investment professionals.

The combination of high costs and even higher risks led to the termination. As reported by Union-Tribune:

 Salient had been collecting more than $8 million a year to manage the county portfolio . . . [The firm's] fondness for so-called alternative investments like credit default swaps and derivatives at one point exposed the fund to potential losses of more than double the portfolio value. A worst-case event could have lead the county to lose its entire fund and owe billions more. (Emphasis added)

To reiterate our conclusion from last year: A city, county or municipality that fails to appropriately fund its pension plan isn't honoring its fiduciary obligation to its employees and retirees. Not saving enough to meet its retirement obligations shouldn't be an excuse for risky behavior or using additional leverage.

There is no free lunch. Instead, pension funds should keep it simple, manage a basic global allocation of assets and watch costs. There simply is no reason to try to reinvent investing when there is a perfectly viable and preferable option.  

(Corrects fourth paragraph of article published July 17, which said that San Diego County's pension-fund returns ranked in the 84 percentile among funds for the past three- and five-year periods. The fund's three-year returns ranked in the 84th percentile for the period ended Dec. 31, 2014, while five-year returns ranked in the 54th percentile. Also corrects Salient Partners' annual management fee in fifth paragraph to $8 million rather than $10 million, and the fund's average annual returns in the seventh paragraph to 10.1 percent not 9.7 percent.)

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author on this story:
Barry L Ritholtz at britholtz3@bloomberg.net

To contact the editor on this story:
James Greiff at jgreiff@bloomberg.net