San Diego County’s odd pension saga ends

The San Diego County government has long held itself in high regard, boasting of its fiscal reserves, reasonable labor contracts and stable services. This attitude was reflected in 2012, when county Chief Administrative Officer Walt Ekard used his retirement announcement to the Board of Supervisors to say, “I have been privileged for the past 13½ years to lead the finest local government in America, and I say that without fear of legitimate contradiction.”

When county supervisors were asked about this prideful stance, they’ve long pointed to the city of San Diego’s financial struggles — triggered by disastrous decisions by the City Council to intentionally underfund the local pension system in 1996 and 2002 — as a sign of their superiority.

But this narrative of “county smart, city dumb” has been badly undercut by the county’s own pension travails since 2009. The problems haven’t been financial; the San Diego County Employees Retirement Association has had one very good year during that span but overall average to somewhat above average returns. Instead, the negative headlines have been generated by an unusual — even unprecedented — level of deference that the SDCERA board gave its lead investment strategist before formally cutting ties with him this month.

The strategist — a charismatic, personable Texan named Lee Partridge — was hired by SDCERA in 2009 after an unremarkable stint advising the Texas teachers pension system. Yet the terms of his appointment suggested the SDCERA board thought it was getting the Warren Buffett of investment gurus.

Examples of Partridge’s special treatment by the board:

• He was paid more than four times the $210,000 salary of the investment adviser he replaced in his first year, and his compensation grew far bigger in subsequent years. The pension board only got around county legal limits on his salary by reclassifying him as a consultant. Many key details related to his compensation weren’t initially revealed.
• He was allowed to work out of Houston.
• He and his firm were allowed to have other clients.
• His plan to outsource investment research to employees of a company he controlled was given the go-ahead by the board. It was only derailed after attorneys warned that it wasn’t just a huge conflict of interest for Partridge to benefit financially from a plan he crafted; it was plainly illegal under state law.

National honor — followed by national incredulity

But Partridge remained in the good graces of the pension board after his aggressive investment strategy yielded strong returns in fiscal 2010-11 and won him the Small Public Fund Manager of the year honor from Institutional Investor.

But when returns lagged, Partridge kept getting more aggressive. In 2013 and 2014, Union-Tribune business columnist Dan McSwain — a businessman-turned-journalist and a savvy student of investment practices — laid out how unusual and risky the Partridge approach was for a government pension fund. His Aug. 9, 2014, column, headlined “County bets all-in at pension casino,” led to front-page coverage in The Wall Street Journal, which led to broad national attention.

Here’s part of it:

Don’t bet more than you can afford to lose. …

 

This basic life lesson, to risk only within your means, has somehow escaped the people who oversee San Diego County’s public pension system.

 

In April, pension board members unanimously approved a new investment strategy that dramatically increases use of “leverage,” a form of borrowing.

 

There’s nothing inherently wrong with leverage, which allows you to buy a lot of asset with a little equity. But it also magnifies losses when markets turn against you, as millions of homeowners learned in the recent real estate crash.

Hoping to beat odds — day after day after day

McSwain noted that the SDCERA board had been denied access to experts who questioned Partridge’s approach and that such a list of experts would start with Warren Buffett. Yet as of July 1, 2014, Partridge was …

… authorized to use the county’s $10 billion fund to put at least $20 billion at risk, mostly with options, derivatives and other arcane financial instruments.

 

Under the previous policy, Partridge was limited to 35 percent leverage in the county’s portfolio. Now he gets to place bets amounting to 100 percent.

 

And while the previous policy approved leverage to bet on the direction of relatively stable U.S. Treasuries, the new policy moves much of the county’s nest egg to volatile areas of speculative investing. Foreign junk bonds, emerging-market stocks, options on the future value of zinc … almost anything is fair game. …

 

Partridge is a very smart guy. However, his success depends on being smarter, every day, than the very smart people on the other side of his trades.

Pensioners turn on pension board

The national media coverage of the SDCERA strategy was as incredulous as McSwain’s column. This led county pensioners to begin attending pension board meetings and ask board members variations of the question, “Are you nuts?”

By November, only one board member opposed a resolution to end the county pension agency’s relationship with Salient, the Houston-based firm Partridge established that earned tens of millions in county fees the past six years.

This month, the final links to Partridge were severed. His replacement, as many expected, couldn’t have a more conventional background. Stephen Sexauer previously …

… worked at Allianz Global Investors as Chief Investment Officer of Allianz Global Investors Solutions, managing over $7 billion in multi-asset institutional portfolios and retirement income solutions. Mr. Sexauer is also the co-author of papers on retirement portfolios published in the Financial Analysts Journal, The Institutional Investor Journal of Retirement, and The Retirement Management Journal. He graduated with an MBA in Economics and Statistics from the University of Chicago, IL.

Salient, meanwhile, has established itself as one of Houston’s largest money-management firms, and now has a San Francisco branch. But it seems unlikely to attract many government clients after Partridge’s unusual stint in San Diego.