A large California pension manager is using complex
derivatives to supercharge its bets as it looks to cover a funding shortfall
and diversify its holdings. The new strategy employed by the San Diego County
Employees Retirement Association is complicated and potentially risky, but
officials close to the system say it is designed to balance out the fund's
holdings and protect it against big losses in the event of a stock-market
San Diego's approach is one of the most extreme examples yet
of a public pension using leverage—including instruments such as derivatives—to
boost performance. The strategy involves buying futures contracts tied to the
performance of stocks, bonds and commodities. That approach allows the fund to
experience higher gains—and potentially bigger losses—than it would by owning
the assets themselves. The strategy would also reduce the pension's overall
exposure to equities and hedge funds.
The pension fund manages about $10 billion on behalf of more
than 39,000 active or former public employees. San Diego County's embrace of
leverage comes as many pensions across the U.S. wrestle with how much risk to
take as they look to fulfill mounting obligations to retirees. Many remain
leery of leverage, which helped magnify losses for pensions and many other
investors in the financial crisis. But others see it as an effective way to
boost returns and better balance their holdings.
One of the main goals is to avoid an overreliance on the
stock market for returns. Like many public plans around the country, San Diego
County's fund doesn't currently have enough assets to meet its future
obligations. The plan is about 79%
funded and it gained 13.4% last year.
San Diego's new approach is comparatively complex at a time
when some big pension plans are moving in the opposite direction. The country's
biggest pension, California Public Employees' Retirement System, is weighing a
number of changes to its investment strategy designed in part to simplify the
portfolio, The Wall Street Journal reported this week.
San Diego-area residents are well-acquainted with pension
problems. A decade ago, the city's pension, which is separate from the
county's, endured a scandal after its accounts were found riddled with errors,
though the matter didn't involve sizable investment losses. Then, in 2006, the
collapse of Connecticut hedge fund Amaranth Partners LLC created tens of
millions in losses for the county's fund. Amaranth made a series of risky bets
on natural-gas futures.
Public funds still have most of their assets in stocks, but
many funds that were burned by the tech-stock bust and the 2008 financial
crisis have turned to private equity, real estate and hedge funds as
alternatives. Public pensions for years have had indirect exposure to borrowed
money through property or buyout funds, but most have steered clear of putting
more money at risk than they have in their portfolios.
The State of Wisconsin Investment Board was one of the first
to embrace the leveraged approach. Trustees in 2010 approved borrowing an
amount equivalent to 20% of assets for purchases of futures contracts and other
derivatives tied to bonds.
Wisconsin's fund has remained among the healthiest public
pensions in the country and currently has enough assets to meet all future
obligations to retirees. The current amount at risk on Wisconsin's strategy is
roughly 6% of the fund's $90.8 billion in assets.
here to access the full article on The Wall Street Journal.