STUMP » Articles » Public Pensions Watch: Dallas Pension Learns About Concentration Risk » 20 August 2014, 12:49

I am having trouble with this one.

I mean, there’s good, there’s bad, and there’s godawful.

Guess which one this is:

This is worse than we feared. The Dallas Police and Fire Pension Fund had already warned members to expect less than the predicted 13 percent return the system’s management hoped for in 2013.

Its leaders downgraded that figure to 8 percent.

Well, the numbers came back today. The actual return was 4.4 percent for 2013.

This was a year when the S&P 500 returned 29.6 percent and the Dow Jones Industrial Average was up 26.5 percent.

Many (most) public pensions have their fiscal year go from July 1 to July 1, so a bunch of financial results come out during July and August. I’ve not been running the stories about “Oh, we had very good results this past year, well above our target return”, because that’s a bit beside the point. The entire market had a good year. Even bonds did well.

But the Dallas Police and Fire Pension Fund did not do well (and the guy in charge, longtime administrator Richard Tettamant, was ousted before this was disclosed, but it was known to be bad as noted above.)

So what sunk the fund? If it couldn’t get above target in a good investment year, that means something had to have performed extremely poorly.

Here’s the performance memo explaining the problem:

Private Equity Performance

Certain of our largest private equity managers did not perform well in 2013. Huff Energy returned negative 29.7% in 2013, as our investment was written down from $200 million at 9/30/2013 to $142.9 million at 12/31/13. Huff Energy was written down primarily because of declines in oil prices at year-end. Additionally, our largest private equity investment, Red Consolidated Holdings, was essentially flat for the year. Combined, these two investments make up approximately 45% of our private equity portfolio and were large contributors to the portfolio’s underperformance.

Two investments — almost half of the private equity holdings. And private equity is 19% of the portfolio.

Yes, the real estate also went down, but I can’t get away from this. Almost 9% of the portfolio was two underperforming assets. That’s called concentration risk.

Private equity, direct holdings in real estate, and other illiquid holdings are very dangerous if they are a substantial portion of one’s investments, and these were.

When a life insurer holds private equity, because they have to hold capital that’s worth about 50% of the value for that (or maybe it’s 100%, I haven’t done the RBC calculation in a long time), they barely hold any of their portfolio in that. The entire private equity portfolio, much less holdings in a single entity, is usually less than 2%. Most of the time, they have none at all (unless it’s from parent to subsidiary or vice-versa, but that’s not an investment backing liabilities per se.)

Ted Siedle has been going after these sorts of investments for public pensions for some time. If there’s one piece from him you should look at, it’s this: Private Equity Secrecy Poised to Implode.

Public pensions have been desperate for returns, as they don’t dare ask for real taxpayer contributions to make up for all their prior losses and, most specifically, for the undercontributions to the pensions.

If people twenty years ago didn’t pay for the service done twenty years ago, current taxpayers do not feel all that obligated to make up for that. (What are the retirees going to do? Strike? From Florida?)

So the pension fund managers try to make up the difference with high returns.

Which means the risk of even bigger holes occurs.

WHEEEEEEEEEEEEEE

Compilation of Dallas posts