San Diego County Retirement Board To Decide Chief Investment Officer's Fate

TOM FUDGE: Our top story on Midday Edition, tomorrow the San Diego County employee retirement board will vote on whether to terminate its contract with the chief investment officer Lee Partridge and his firm, Salient Partners. At issue are the high salaries Salient receives, and the risky investments the firm is using to boost the county pension fund. Critics say the use of leverage in future markets are putting the public funded serious risk. Taxpayers can be forced to restore the fund, which is worth about $10 billion if investments goes out. Joining me to talk about this subject are Bill Sheffler and Phil Blair. Bill, the chief investment officer's job when it comes to the county pension is on the line this week because what some people are calling risky investment strategies based on leveraging. Tell us, first of all, how do leverage investments?? WILLIAM SHEFFLER: In this strategy, the leveraging that they are talking about involves borrowing and putting those investments into the market you are using borrowed funds, and putting those into the market at risk. TOM FUDGE: So if the market goes south, you have to return the money? WILLIAM SHEFFLER: Yes you do. Regardless of your losses. TOM FUDGE: We hear they are also investing in bond futures, is that also risky investment? WILLIAM SHEFFLER: It depends on how you articulate that particular investment. You can use it to hedge, or limit downside risk, or to enhance upside risk by buying the futures, which act as proxies for bonds. TOM FUDGE: I guess I have asked you to explain those strategies, what do you think of them as they apply to county pension fund? Are they a good idea? WILLIAM SHEFFLER: The strategies unproven, and I am not sure that we want to use public money to advance this strategy in the marketplace. I would much rather let private investors and public sector funds, which are much more accountable than the public sector funds. Do that kind of experimentation, prove the efficacy of this strategy. TOM FUDGE: Are these strategies risky? Is that a problem? WILLIAM SHEFFLER: They involve significant risk, and this is a very complicated strategy to put into a system like this. You have to analyze the risk portfolio of every asset class in the portfolio, and find a vehicle that can either hedge or leverage that particular risk. If you missed a risk, you're out to lunch. TOM FUDGE: Speaking of being out to lunch, I have heard some people say, and some people have been quoted in newspapers saying that this kind of investment strategy could wipe out the entire fund. Is that true, was that hyperbole? WILLIAM SHEFFLER: It is an exaggeration to the fund could suffer substantial losses. This fund, the fund is only by a system actuary standard, 79% funded. If we apply it sector rules to the plan, it would be over 50% funded. Trying to make up that deficit using investment earnings is not going to make a difference. It must be made up with increased contributions, which is what the board is trying to avoid doing. TOM FUDGE: How good of a job do you think Salient Partners have done with their investment strategies? WILLIAM SHEFFLER: They have under performed San Diego over the last three years. The city of San Diego made 14% over the last three years, Salient and the county made 12%. At the same time, Salient charged more than twice as much for investment management as the city of San Diego. TOM FUDGE: It sounds like you are arguing that the county is not getting what they are paying for. WILLIAM SHEFFLER: It does not sound like that to me there. TOM FUDGE: I am going to get Phil Blair involved in the decision in a minute, but let me read to you a comment from the CEO of the San Diego County retirement Association, his name is Brian White. We invited him to be on the program but he turned us down. He said in an op-ed, in UT San Diego, risk parity and trend strategies which utilize leverage our limited to 25% of the SD SERA, the county pension fund, not the entire set of portfolio assets. The other 75% of the portfolio is managed using traditional asset allocation and rebalancing approaches. He is arguing that this is not all the money, they are not taking a huge risk. What is your comment on that? WILLIAM SHEFFLER: You may be only using 25% of the plan assets for strategy, but because you leverage, you end up putting more than 25% of the assets at risk. TOM FUDGE: How much of the assets do you put at risk? WILLIAM SHEFFLER: The numbers I've seen have gone up to $10 billion, that is the entire portfolio. We're talking about 125%, but I cannot be confident of that. TOM FUDGE: What do you think? Should the county fire Salient Partners? WILLIAM SHEFFLER: I think they need to review this risk parity strategy formulation that they have. They really have not given Salient enough time to show what they can do outside of the risk parity strategy. TOM FUDGE: It sounds like your answer is no, you think they should give Salient more of a chance? WILLIAM SHEFFLER: I believe so, yes. TOM FUDGE: Phil Blair, what do you think about the risk that the county is taking? PHIL BLAIR: Just like any investment that you take, were aboard that you represent on an investment fund, you have to be comfortable that the staff that you are hiring is comparable with what you're asking them to do. If Lee Partridge is doing what the board directed him to do, he should keep his job. If his overhead expenses are exorbitantly high, that needs to be renegotiated. If there is no value in that expense, you always look at the net cost of service, not just the earnings. The risk adversity is something that the board should become will with. But if you can borrow at 2% or 3% and get it 13% return, that is pretty successful. I would question why the city is at 14%, and this much more expensive consultant has a 12% result. But I think the issue is also bigger than just hiring or firing one consultant, it is what the future of the fund should be, who should make those decisions, and the defined benefit and contribution plan. TOM FUDGE: Phil, do you support the idea of using leveraged investments for a public pension fund that taxpayers may have to pay back if it goes south? PHIL BLAIR: I don't as long as the taxpayers are at risk. But if employees and retirees are at risk, that is their decision. If they want to be extremely risky and hopefully have an avalanche of an offense, that is their decision to make. That is where I think we should be going with this program, rather than the discussion we are having now of someone else making the decision on their income. TOM FUDGE: But taxpayers aren't risk, right? In terms of the county pension fund, the $10 billion fund? WILLIAM SHEFFLER: They are entirely at risk when it comes to the investment returns, yes. TOM FUDGE: And Phil, you feel they should not be at risk, what kind of pension system do you favor? What kind of changes do you think should be made? PHIL BLAIR: The current plan is a defined benefit, which means that you are guaranteed benefit when you are retiring. It does not matter whether the funds does well or not, you get the same benefit. The differences defined contribution, where you take a risk, and your pension payout month by month is predicated on how well the funds does. If you and your peers want to maximize income, you will go into riskier ventures. But eyes wide open, it is your decision to make and how risky this will be. I think the owners, and the benefits and lack of benefits should be on people who are going to benefit or not. That is the issue that I see that is different. And what should go forward, the county should be designed the pension plan. TOM FUDGE: This is what the city of San Diego has done, right? They have gone to a defined contribution plan, not a defined benefit plan. The risk is on employees, not on the city and the taxpayers. WILLIAM SHEFFLER: It is exactly what they have done, and I have worked hard on Proposition B to get that passed with a cost analysis. However, with respect to the county, I also did an analysis for Ventura County. That initiative was thrown out of court, because the court decided that counties are under different laws, and are constrained, and cannot get rid of defined benefit plans. TOM FUDGE: We do not have a union member here, and if we did, you would probably be opposed to the idea of a defined attribution plan putting risk to employees. Some may argue that if you have that kind of pension plan, it will be hard to attract good workers to the public sector, because they can get higher salaries in the private sector, so you have to give them a good pension. What do you think of that argument, so? PHIL BLAIR: Having a difference is, I'm not only supporting changing the way that it had become a defined contribution, but that they take control of their plan themselves, and elect their board, and they elects people who make investment decisions. They can be as conservative as they want to be, and that empowers them to make good decisions they are comfortable with long-term. It takes the taxpayers out of the equation, because the pensioneers are voting on a board to invest money in the way that they wanted invested, instead of a arm's-length board that does not take investment from pensioneers. TOM FUDGE: Bill, I think I mentioned at one point that you served on the city of San Diego pension reform committee after the city underfunded its pension when we look at the case of the city, and the current underfunding of the county pension, is it the same thing? WILLIAM SHEFFLER: I think the causes are different, and the solutions will be different, because we are constrained from what we did with the city that is bringing on a defined contribution plan. But there are significant reforms that can be made of the county. For instance, the board has nine members, only three of whom are required to have substantial financial background. You have six members and the majority of the board making decisions on a $10 billion fund, without appropriate education or development. TOM FUDGE: How much of the county pension fund is actually funded? Is it 75%? WILLIAM SHEFFLER: The actuary has said that the plan is 79% funded using rather high interest expectations of future earnings. If we use reasonable expectations of future earnings, that number comes down to about 58%. That is a very low number. If it was private sector, the IRS would step in, suspend benefits, and require substantial increases in contributions. TOM FUDGE: If I look at Lee Partridge and his company, I guess it could be a little bit sympathetic. He has got a county government that wants to give generous pension benefits, but they do not want to pay for them. So, they want their investment firm to take risks, so they can make money. Do I have that right? Does the county want to have its cake and eat it too? PHIL BLAIR: I think I would bifurcate that. They want high returns, not high risk. In an ideal world, you cannot have both. I realize it may take legislative change to allow counties to modify pension plans, but that is done all the time, that is easy to do. We should not slam the door on the concept because the court rules a certain way. The court is interpreting the current law. If the law changes, changes can be made. I think the big picture here is having beneficiaries of the pension on the board, making decisions about the board, and I agree that there are criteria for a financial ground. That is really important in these situations. But these people control their own outcome. If they want to be risky or conservative, let them do it. But let us get the taxpayers out of the middle. They agreed to pay X amount every year. Let the taxpayer paid it, and be done with the decision. TOM FUDGE: When we look at the county pension fund, is there a problem with it, and what is the solution? WILLIAM SHEFFLER: I think the solution is more contribution by employers and employees. That is the way they will take themselves out of this particular hole. TOM FUDGE: Thank you both very much.