San Diego County Fires Its High-Priced, Leveraged, Underperforming Outside Manager

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.

(Note: 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.)



Originally published as: A Pension Fund Comes to Its Senses



Print Friendly, PDF & Email

What's been said:

Discussions found on the web:
  1. CD4P commented on Jul 17

    Good to hear they fired some folks who should be driving for Uber!

  2. VennData commented on Jul 17

    This is left-wing political payback for the millions and millions of jobs Texas is taking from the kooky Californians where nobody wants to live.

    Texas is a wonderful place with people like Ted Cruz and Rick Perry and the Jade Helm Defenders. Where George W. Bush learned foreign policy and fiscal management. And made millions in oil. Where textbooks tell the truth and Where Donald Trump is rising in the polls daily.

  3. DeDude commented on Jul 17

    There is absolutely no excuse for failing to fund your pension promises to public employees. Whatever you promise them you can easily calculate the cost (with conservative assumptions for investment returns). That should be the amount of money put into the funds every year. Unfortunately, the public pension funds are not required to retain the same level of funding as the private pension funds, and making things even worse is the tendencies to short the contributions when the economy is down (and stocks are cheeper). We either need a stronger demand on funding levels (including leverage and risk associated adjustments) or to put public employees on the same pension system everybody else have. Let them into the social security system and supplement with a 401K.

    • Iamthe50percent commented on Jul 17

      There is also sweetheart deals with politically connected firms.

      ” Let them into the social security system and supplement with a 401K.” What you are suggesting is basically the federal FERS system. The “401K” part, TSP (thrift savings plan), has lower fees than any mutual fund or ETF. The total size is, IIRC, about two trillion dollars, so a 0.1% fee goes a long way. BTW, 100% index funds except for the G fund which is essentially a money market fund.

      A direct quote from the web site – “For 2014, the average net expense was $0.29* per $1,000 invested.” So a 0.29% fee goes a long way too.

  4. SecondLook commented on Jul 17

    …the public pension funds are not required to retain the same level of funding as the private pension funds…

    I assume you’re talking about ERSIA – The Employee Retirement Income Security Act of 1974. While ERSIA does mandate, in theory, better funding of pension plans, it is loose about estimated rates of return on investment. Something that a number of companies have taken advantage of to effectively under fund their plans.

    Of course private sector defined benefits plans – i.e. pensions, have been in steep decline for decades, to the point of almost being completely irrelevant for anyone under 50 or so, outside of those who work still in manufacturing.
    The terrible irony is that even poorly managed private or public pension funds in general will still provide better retirement income than the vast majority of 401K’s…

    • DeDude commented on Jul 18

      I agree that if fully funded, the defined benefit plans will give more in pensions than 401K plans. But 401K’s are in addition to social security, whereas in the public sector the defined benefits are usually instead of social security. If defined benefit plans in the public sector were not robbed and raped the way they are these days, I would certainly support the idea of keeping them. Problem is that these plans are subject to cuts from right under people who had planned their retirements based on them. Politicians are eventually faced with the consequences of decades of underfunding (raiding pension funds). Politicians then have to choose between tax increases (to fulfill the obligations) or cutting pensions and health benefits for retired people; sadly that’s a “no contest”. Those close to or already retired are then left worse off than if they had been enrolled in social security and Medicare and had a 401K plan for the rest. I know that in theory if the same money is placed in social security vs. even a poorly run defined benefit plan the defined benefit plan wins because it is invested in a broad portfolio (rather than 100% treasuries). But when you start counting the unpredictable changes and benefit cuts, that advantage gets smaller, and may not be worth it.

Posted Under