[quote=bearishgurl]
Uh, well, I don’t think our fact-skimming newbie, Phaster, had a chance to see this recent piece from the UT (hint: google SDCERA and it comes up first :)):
…. For the past decade, San Diego County and its employees paid 100 percent or more of their annually required contribution to the SDCERA retirement fund. Consistent employee and employer contributions over the years have laid a foundation for investment gains and asset growth. SDCERA’s investment strategy helps the employer’s budgeting process and stabilizes employer costs by reducing the volatility of returns and steadily achieving the rate of return needed to fund the benefit.
At $10 billion, the SDCERA fund is able to pursue certain investment strategies that larger plans like CalPERS cannot access and smaller plans do not have the resources to deploy. SDCERA’s investment strategy is purposely designed to be no riskier than traditional pension fund asset allocation strategies. Risk-parity and trend strategies, which utilize leverage, are limited to 25 percent of the SDCERA portfolio, not the entire set of portfolio assets. The other 75 percent of the portfolio is managed using traditional asset allocation and rebalancing approaches…
I’m just a knuckle head that is honest enough to admit that I’m not a “investment expert.”
Since I am not an “investment expert” I won’t buy into the latest investment fad hype (such as “risk parity”) without pondering the downside.
Nor do I pretend to understand all the details about Tier “a” employees vs Tier I/II employees, or care about employees that say they paid their annual required contribution, because basically my goal is to try to understand general trends.
To that end, the wall street journal article as I understand it has three key facts:
1) SD county has “currently” about 10 billion in its pension fund account
2) there is some kind of pension short fall (i.e. underfunding issue)
3) to make up for the “unfunded” pension obligations, the pension board adopted a strategy to use “leverage” on the order of 100% (in other words taking out a loan equal to the amount the pension board has in its account or a total of about 20 billion bucks and playing the markets)
Next I know if I go to a broker, I can place money for “investing” in one of three general types of account(s):
Perhaps its just me but after reading the “definitions” from the “investopedia DOT com” website, and “skimming” a typical broker website, the reported decision to borrow 10 billion against the 10 billion the SD pension board has in its account – sure looks like the definition of a “margin” account (with its associated risks)
One reason I’m guessing the SD pension board emphasize they are investing using “risk parity” in a “press release,” is its a marketing/spin/propaganda ploy.
Basically they (the SD pension board) are selling the idea to the joe/jane taxpayer, that the “derivatives” strategy involves little or no risk (something akin to why the name “credit default swap” was given to what is essentially “insurance on a bond”).
FYI while trying to understand why the economy imploded a few years ago, I read if the term “insurance” was used instead of the term “CDS” (credit default swap), then an inconvenient rule about the level of capital reserves required by regulators to back traditional insurance policies would apply. BTW guess what exotic financial instrument had a big hand in taking down the economy last time…
Back to the matter at hand, the only conclusion I can draw (translating all the B$ terms and given all the data), is that the SD pension board is seeing the handwriting on the wall with the “change in accounting rules, which requires pension obligations be placed on the balance sheet” and is borrowing an amount equal to what they currently have in the bank and “investing” the whole pile of cash (20 billion) hoping to grow the “value” of the pool of assets and makeup for the short fall.
Like any investor, they (the pension board) are looking for some kind of investment “vehicle” (like: stocks, put options, call options, bonds, credit default swaps which is a fancy name for insurance on bonds that they might or might not own, commodities, derivatives, real estate, etc.) that increases in value.
Given that a “margined account” consists of a pool of money which has to be invested in some kind of investment “vehicle,” it does not matter what the exact asset mix is, because the market “value” for the pool of assets can be looked at as, ending up in one of three states:
1) going down over time
If the “assets” w/in the pension portfolio go down overall, this would be considered a “loss,” on top of which there also would be some kind of “rent” payment paid to the broker (over the life of the “margin” loan)
In absolute terms if all the “assets” were sold off and the loan from the broker paid back, there would be a lot less money in the pension account (than at the beginning).
Perhaps as described in the “risk” section describing a “margin account,” the pension board might owe the broker more money than they initially bet, BUT it won’t matter to them because no matter what happens the taxpayer picks up the tab.
2) holding more or less, “constant” over time
If the “assets” w/in the pension portfolio are constant over time, the fact of the matter is this too would be considered a “loss” because some kind of “rent” payment will have to be paid to the broker (over the life of the “margin” loan).
In absolute terms if all the “assets” were sold off and the loan to the broker paid back, there would be less money in the pension account (than at the beginning).
Again in this case, any pension shortfall would be backstopped by the tax payers.
3) going up over time
If the various “assets” w/in the pension portfolio go up overall, this “might be considered a win” BUT like in the two cases above, one also has to consider the drag of servicing the “margin” loan (and also thrown away costs of “unused” expired options, etc., which is also a consideration in the two cases above).
But for sake of simplicity, lets ignore debit service payments, etc. and just say the PortfolioValue(final) > PortfolioValue(initial), then this would considered a “win!”
In this case “hopefully” the pension pool assets grow in value fast enough to satisfy the promises made by past political leaders to public employees (i.e public employee union members), and the tax payer is off the hook. Basically this is the la la land, “Hollywood” fairy tail happy ending!!
So (at best) I basically see the simple odds being 1/3 “successful” vs 2/3 “unsuccessful” (and a very “deadly” downside) with the reported SD pension “derivative” portfolio strategy
Knowing there are three basic “endgame” states, I guess I could write a fancy monte carlo computer simulation, and forecast the exact date of the SD pension fund implosion and $uckness for all parties involves (i.e. exact doller values).
But such a forecast would only be a “guesstimate” because its impossible write an equation that accurately describes the psychological pain of all players in the system, along with their responses.
It is this impossibility to write an exact math equation which describes all the variables and gives exact predictive answers, which is why “economics” is called “the dismal science”
I know it is impossible to remove all risk from a portfolio, yet get the feeling the SD pension board thinks otherwise (and is tying to sell their idea to the financially illiterate public/taxpayers)
Just hope my worst fears don’t come true, cause from what I’ve read and understand about markets, the derivate strategy for managing what should be boring and safe “retirement” portfolio, could economically implode in a spectacular fashion.
