Published in the Pacific Coast Business Times, August 23, 2013
Thanks to rising U.S. and foreign stock markets, major public pension plans in the Tri-Counties exceeded expected investment return rates for the last fiscal year. But Santa Barbara County’s performance lagged far behind its peers.
Ventura County Employees’ Retirement Association and San Luis Obispo County Pension and Trust saw net returns of 12.8 and 12.9 percent, respectively, well above the pensions’ assumed actuarial return rates of 7.75 and 7.25 percent. While Santa Barbara County Employees’ Retirement System’s 7.85 percent return exceeded its target of 7.75 percent, the pension underperformed an average composed of similar public funds.
Santa Barbara County System CEO Gary Amelio said there was a combination of factors to blame for the pension’s below-average performance for the year ended June 30.
One was the heavier emphases the portfolio places on emerging market equities and inflation-protected assets. The second was a shift in about $1 billion of assets to go along with the new allocation mix.
U.S. stocks outperformed emerging market equities by a margin of about 19 percentage points this year, as funds with higher domestic equity allocations put in one of their best years in decades.
Amelio said the fund based its decision to invest on emerging markets’ strong record of long-term performance in recent years and high expectations for the future. However, Kevin Bernzott, chairman and CEO of Camarillo-based Bernzott Capital Advisors, said investing in newly developed economies is a highly volatile prospect because of a lack of comparable financial standards.
“Emerging markets are always much more risky because you are dealing with foreign countries that don’t have similar accounting standards, that don’t have oversight by the SEC,” Bernzott said.
Additionally, low U.S. inflation rates and expectations caused the Santa Barbara County plan’s 19-percent investment allocation towards inflation-protected assets to fall short against stocks that thrive off of lower inflation, Amelio said. These assets are meant to have an edge over stocks when inflation increases, and Amelio said the amount his fund allots to this asset class is generally higher than most other public funds.
“We are a little more diversified than perhaps some other funds. We want to reduce our risk while maintaining a return,” Amelio said.
Amelio said the fund also underwent a process to shift more than $1 billion in assets across various classes in order to reach the new allocation, a policy launched during the first quarter of 2012. He said the transition was part of a newly adopted strategy aimed at reducing risk by expanding investments in long-term assets. The bulk of the changes were completed by last month, but the transition period resulted in a modest amount of short-term drag to the annual return, Amelio said.
Officials from the San Luis Obispo and Ventura county plans credited domestic and international equities as the primary driving force behind their strong performances this year. The SLO plan has a 33.3 percent target level for domestic investment and Ventura County 37.5 percent, whereas the Santa Barbara plan has a much lower 21-percent allocation target.
“Anybody who had anything in equities did pretty well this year,” Ventura County CEO Michael Powers told the Business Times.
Officials and experts stressed that because of the time frame that pensions operate on, single-year performance provides little indication of the overall financial health of a pension. Year-by-year returns can vary greatly depending on specific investment strategies and risk factors, and it is much more telling to take into account averages over a longer period.
Santa Barbara and Ventura counties are among the 20 county pension plans in California that operate independently from the California Public Employee Retirement System, or CalPERS, in accordance with a set of legislative regulations known as the County Employee Retirement Law of 1937. CalPERS, the largest pension in the U.S. which manages funds for 3,000 state public employers, saw a return rate of 12.5 percent last year.
The SLO County plan is also independent of CalPERS, and is instead set up through a separate charter. It and San Franciso County’s pension fund are the only state counties operated in this manner. Carl Nelson, executive secretary at the SLO plan, said the distinction is practically negligible in terms of the way the pensions are governed.
Amelio said the expected return rate is determined by the pension’s retirement board, consultants and actuaries. The number reflects the anticipated average return of investment each year over a 17-year “open/rolling” amortization period based on actuarial and economic assumptions.
Assumptions are based on a range of factors such as past performance and accepted level of risk, he said. Ventura County uses a 15-year closed amortization while SLO operates on the more commonly used 30-year period.
Bernzott said pensions tend to be more weighted towards equities than other portfolios because their longer time frame allows them to dilute the risk over time and gives them more opportunity to hold out for a high return.
Bernzott said larger funds have more leeway to stray from traditional asset classes and move into alternative investments such as hedge funds or private equity, a trend he sees more and more among pensions struggling to keep up with rising costs. However, he said this does not mean that size has any correlation with whether or not funds are engaging in risky investing, and strategies are specific to each organization.
Ventura County has the largest of the three Tri-County pensions with a market value of approximately $3.6 billion as of last spring. The Santa Barbara County fund is valued at about $2.2 billion and SLO at about $1.1 billion.
Despite the upswing in returns, the hangover from the 2008 collapse that caused returns in all three pensions to drop into the negatives continues to loom over the funds’ performance. All three funds are still below expected return in five-year averages and hover just above or below the mark in 10-year averages.
Ventura County Taxpayers Association Chairman David Grau said rising retirement costs can push pensions into striving for unrealistic returns. He said this is particularly concerning when failure to meet these marks causes unfunded liabilities, or gaps between promised benefits and available funds to fulfill them, to build up. Grau said the burden eventually falls on the county to make up the difference via increased contributions to the plan.
“The problem is that as they make promises to employees, they have to go into more exotic types of investments that have a lot more risk,” Grau said. “I’m just concerned that the expectation of the county making 7.75 percent every year in the future is a bit unreasonable.”