STUMP » Articles » Public Pensions and Alternative Assets: Dallas Shows How It Can End » 21 September 2014, 08:00

Back in August, I wrote about the Dallas Police and Fire Pension fund losing a lot of money. From that post, we see that 2 of their private equity investments did extremely poorly, representing 9% of that overall portfolio.

From the end of that post:

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.

As noted, it wasn’t only private equity that did poorly, but also their real estate holdings.

Let’s see just how badly those did:

The retirement fund for Dallas’ police officers and firefighters lost $196 million on risky real estate investments in recent years, according to figures given to the fund’s board Thursday.

It is the fullest accounting yet of the $3.3 billion fund’s disastrous plunge into speculative development ventures that began in 2005. The failed investments include a luxury resort and vineyard in Napa County, Calif., ultra-luxury homes in Hawaii, and large tracts of land in Arizona and Idaho.

The ventures prompted the fund’s staffers and board members to travel extensively over the years, trips they said were necessary to scope out and protect the investments. They traveled to the Napa area more than any other out-of-state destination — making 45 trips there from 2009 to 2012.

……
These losses played a major role in bringing down the fund’s 2013 investment return to 4.4 percent. Fund officials earlier had expected a return of 11 percent. Similar public funds had a return of 16 percent for the year, according to the Wilshire Trust Universe Comparison Service.

The 2013 write-downs came from new appraisals of the various properties. The fund undertook these appraisals as it revamped its accounting procedures. The changes came after The News reported that the fund valued many of its real estate ventures by what it had invested, rather than by appraisals or other methods. This was contrary to widely accepted standards.
……
The poor 2013 results prompted the board this summer to oust longtime fund administrator Richard Tettamant.

The $196 million in losses came from three real estate plays:

A set of ventures that included tracts of land in Arizona and Idaho ($90 million loss).

Luxury resort properties in the wine country of Napa County, Calif. ($46 million loss).

Ultra-luxury homes in Hawaii and elsewhere ($60 million loss).

Tettamant led the fund into these deals with little oversight from outside investment advisers. Instead, he and his staff handled many of them personally. He met developers, who introduced him to other developers.

Now, in this case, it’s not hedge funds, but direct investment in real estate. But again, the point is that these real estate investments, like hedge funds, aren’t publicly-traded stocks and bonds, which have certain accounting standards, market valuations, and public markets in which to trade these instruments. Even for privately-placed bonds, there are legal protections for investors, such that the debt has to be discharged in bankruptcy.

There is a lot of opacity in investing in real estate, just as with hedge funds, and there is quite a bit of illiquidity to these assets. It is difficult to get values one can trust for these investments, because it may be overvalued right up until the point you try to sell it to someone else.

Let us figure out the impact of this almost-$200M loss — as per this performance memo, the real estate investments as a whole made up 18% of the portfolio. This is on a par with the private equity investments.

The fund as a whole is valued at $3.3 billion, so that means the investment was about $600 million as a whole. I don’t know if that’s supposed to be before or after the about-$200M loss, but that’s a huge loss. Even supposing the value was originally $800M, and went down to $600M, that’s a 25% loss. Yuck.

This isn’t something special about real estate, but the whole of real estate, hedge funds, private equity, and other alternative assets that public pensions pursue because they have a “plausible” case that these yield higher returns than publicly-traded stocks and bonds.

But it turns out, they don’t necessarily.

What they can do is lose a lot more than publicly-traded stocks and bonds rather rapidly, because their true value can be hidden in their illiquidity.

While that can be very abstract for many people, this is the part that’s not abstract:

While the retirement fund suffered losses, Tettamant and the developers kept making money.

The board awarded Tettamant $78,300 in incentive pay and a $25,000 bonus on top of his $270,000 salary in 2012, before board members became aware of the severity of the losses.

Pension officials have kept Knudson’s company on to oversee the ultra-luxury homes as it tries to unload them. The fund has paid him more than $300,000 a year plus percentages of rental income and sales. As part of his job managing the homes, Knudson has lived in them.

The fund has paid Criswell’s company a total of $3.6 million so far to consult on the Napa projects.

This is why people like David Sirota and Ted Siedle have been focusing on the fees paid to hedge fund managers and the like (including the kickbacks such as nice trips to Napa for pension fund managers). That’s something people understand concretely — that those managing the funds may have incentives that are more about benefiting themselves than benefiting the pensions.

It doesn’t require outright fraud. It only requires not looking too closely at what one is investing in, because one doesn’t have much interest in looking very closely.

Now that Calpers is pulling out of hedge funds, other funds may just start looking more closely at their alternative asset portfolios. But then that would require them to start having to ask for more tax money to fund the pensions.

The tricks are running out. It’s about time.

Alternative Assets series:
Don’t go chasing waterfalls….or Alternative Asset Classes

New Jersey and NJ followup

South Carolina

San Diego

A break for some alternative asset boosterism

Rhode Island

North Carolina

California pension fund pulling out of hedge funds, Immediate reactions to this move, and more reactions to Calpers pulling out of hedge funds

Compilation of Dallas posts