Editor’s Note: This piece is an ongoing investigative series in partnership with Watchdog.org’s state-level journalists. Pension budget woes beset nearly every state in the union and cities and municipalities are also being hit with unprecedented pension debt. Baby boomers are retiring. Some state and local budgets allocate more funds for pensions for retirees than they use for actual services and current worker pay. Once again, the younger generation is saddled with debt from a previous profligate era.
The Houston Police Officers’ Pension System lost 3.1 percent on its investments last year, as its aggressive strategy of leveraging assets has come up empty while exposing Houston taxpayers to menacing levels of risk.
The loss comes as HPOPS has ditched the traditional conservative approach associated with pension funds in exchange for a high-risk mix of junk bonds, real estate investments, derivatives and private equity in an effort to achieve annual returns of at least 8.5 percent.
The downside of that strategy was recently seen in Dallas, where a debacle with a pension fund-owned high-rise led to nine-figure write-downs.
The Houston police’s pension loss also underscores the futility of Mayor Sylvester Turner’s plan to issue $1 billion in pension obligation bonds to solve the unfunded liability crisis.
If Houston had already issued those bonds, and turned $1 billion over to the police last year, the result would have cost around $90 million more than doing nothing.
In addition to losing $31 million in poor investment performance, the city would have had to pay another $50 million to $60 million in interest on those bonds, which go for 5 to 6 percent in the market.
Bill King, the Republican candidate for mayor in the last election, says that the city’s new return target of 7 percent — part of Turner’s plan — is still too high.
“Warren Buffett has said that anything above 6% is ‘nuts,’” he wrote in his newsletter Monday. “And the recent performance of the plans suggests that the 7% target will be difficult to achieve.”
That rate of return is nearly impossible to achieve long-term on cash obtained through a costly pension bond, which would need to return 13 percent year after year in order to cover the interest and still hit the target.
HPOPS isn’t just taking part in leveraged buyouts. In recent years, it has started leveraging its own assets to get more money to play with. It’s not clear how much debt the fund has taken on, but it has set a cash allocation target of negative 10 percent to reflect its leveraged domestic equity portfolio.
The fund has set a target of 47.8 percent of its assets invested in “alternative investments,” a high-risk, high-yield category that was once anathema to pension funds.
According to a global survey by the firm of Willis Towers Watson, pension funds of all sorts had 7 percent of their assets in alternative investments in 1996; that had increased to 24 percent by 2015.
A survey of large pension funds by the Organisation for Economic Co-operation and Development found they had an average of 14.3 percent allocated to alternative investments in 2014.
The category covers a number of investments outside of traditional stocks and bonds, such as hedge funds, private equity, real estate, and various trading strategies meant to beat the market. Many of these involve leverage — the practice of using lots of debt to acquire assets — in order to increase the potential payoff while also cranking up the downside risk.
It’s roughly equivalent to mortgaging your house to buy stock. Either you’re going to make a killing, or you’re going to lose the house.
Pension funds traditionally avoided not just leverage but volatility of any sort, so as not to expose taxpayers to the cost of their mistakes.
Now, many have begun seeking it out, for the opposite reason. Municipal pension funds across the country are at risk of collapsing, and see a high-stakes gamble as their chance to get back on their feet.
When the San Diego Union-Tribune discovered that the county retirement system in the California city had pushed this high-risk strategy to its limits, the paper consulted 16 experts on whether public pension funds should leverage their assets at all.
Twelve of the experts said no, while those who thought the risk worth taking offered words of caution, or argued it should be allowed only with individual retirement accounts.
“Nobody takes these kind of risks with their personal retirement funds and it makes even less sense to do this with a public pension fund,” said James Hamilton, a professor at the University of California-San Diego.