Opinion: Investment Plans for City Pensions Likely to Get Riskier Under Treasurer Summers

As he settles in for his first 90 days as Chicago’s newly-appointed Treasurer, Kurt Summers has made it clear he has big plans for the office he holds and the investments and financial transactions he oversees.

Summers, formerly chief of staff to Cook County Board President Toni Preckwinkle, comes to the job after a long history in the private sector, most notably as a senior vice president with Grosvenor Capital Management, one of the city’s biggest financial services firms.

The mayor appointed Summers to replace outgoing Treasurer Stephanie Neely in October, and, in doing so, all but guaranteed Summers will remain in the job for years to come as Neely faced no opposition to reelection in the upcoming municipal elections.

As part of his responsibilities, Summers sits on the boards of four city pension funds—the Municipal Employees' Annuity & Benefit Fund of Chicago (MEABF), Laborers' & Retirement Board Employees' Annuity & Benefit Fund (LABF), Policemen’s Annuity & Benefit Fund (PABF) and the Firemen's Annuity & Benefit Fund (FABF).

Shortly after taking office, Summers began outlining big plans for the role of Treasurer in helping to solve Chicago’s financial woes, including a renewed focus on ensuring the City invests its capital locally and fixes chronic problems with the city’s pension funds through a mixture of fee reductions and investing in the “right kind of assets.”

On his first day in office, Summers released a 15-point action plan that highlighted “securing lower investment fees”, “identifying and investing in emerging investment managers” and “working to ensure the long-term security of our pension funds” as part of his goals for the office.

The city’s pension funds are woefully underfunded and in crisis, with the funds significantly underfunded by as much $37.3 billion. The firefighters fund is in the worst shape, with assets to cover just 24 percent of future liabilities.

For Summers, finding the right kind of assets for pension funds to invest in is likely to mean significantly changing how the funds’ portfolios work, and moving from more traditional investment choices to riskier, less liquid “alternative” investments. Much of the problem lies in the funds’ receiving less-than-expected returns from investments over the years, and boosting returns is an area Summers hopes to be able to fix with his particular brand of expertise.

Yet, in doing so, Summers is setting a course that directly contradicts not only the behavior of many of the nation’s biggest retirement fund managers, but also what many experts consider a prudent approach to pension fund investing along with potentially the spirit—if not the letter—of the City Treasurer’s fiduciary responsibility to the taxpayers of Chicago.

In November, Summers was quoted in the Chicago Sun-Times as saying finding the right type of assets can help pensions reach their appropriate funding levels faster.

“We’ll have to have portfolio and asset allocation changes to protect our rate of return because ultimately, the taxpayers and retirees are relying on us to hit that number and, if we don’t, they have a bigger bill on the other side of the graduated payments structure.”

That doesn’t necessarily mean being conservative, he said.

“It’s a common misconception to say, `If I invest in the markets or fixed-income [instruments], we’re gonna be protected, but real estate, private equity or hedge funds are risky.’ That’s plain wrong,” Summers said.

Here, Summers was speaking directly to the divide between what investment professionals consider safer, more traditional investments, such as stocks, bonds or mutual funds, and less well-known or “alternative” investments, such as hedge funds or private equity.

As investment vehicles, alternative asset classes are seen as riskier due to a combination of a lack of transparency over how they work, potential difficulty in selling assets should their value drop and complex, often proprietary investment strategies designed to boost returns. In fact, prospectuses and offering documents for alternative investments are required by regulators to highlight their potential riskiness on the face of the documents themselves.

While it may be true that the strategies employed in alternative investments can increase returns, higher risk levels may mean losses can be compounded as well. As a result, alternative investments, if they do not perform as expected, may well run the risk of making the pensions underfunding problems worse.

Currently, at least three of the City’s funds—the Municipal Employees’ fund, and the police and firemen funds—already invest in alternative investments. As of the end of 2013, the MEABF Fund was approximately 24 percent in a mixture of hedged equity, real estate and private equity. In June, 2014, the Fireman’s Fund was 6 percent alternatives, while the Policeman’s Fund was 23 percent alternative in late 2014.

That means, in order to significantly boost returns, the funds will likely to have to increase their share of alternative investments well beyond current levels, a move seen as risky and possibly counterproductive in many sectors of the financial industry--and, in some cases, higher than the industry norm.

“It ramps up the risk significantly,” Ted Siedle, a former SEC attorney and president of Benchmark Financial Services, a pension investigation firm, told Ward Room. “(Summers is) fundamentally wrong that alternative investments by definition, are less risky than traditional investments. That’s why they’re called alternative investments. They’re an alternative to the deep, broad transparent public markets, such as stocks or bonds.”

“The more underfunded a pension fund is, the less risk it can take, because it has to pay a greater percent of its assets out for benefits,” Siedle says. “So if you only have $100 in your bank account and you owe $200, how much of it can you afford to invest in long-term, illiquid high risk investments?”

Recently, no less an investment titan than Warren Buffet has called for public pension funds to cut back or avoid alternative investments due to their unfavorable risk and reward profile. “I would not go with hedge funds — would prefer index funds,” the Berkshire Hathaway founder wrote to the head of a large San Francisco pension fund.

At the same time, Calpers, the largest U.S. pension fund, decided in October to shed its $4 billion in hedge-fund investments over the next year.

Nevertheless, the overall market for public pension dollars has seen a significant shift into alternative investments in the past decade or so. By 2012, the use of alternative investments in public pensions has more than doubled since 2006, with the use of alternative investments reaching 23 percent of all plan portfolios. By some estimates, as much as a quarter of the $3 trillion in public pension funds are already in alternative investments—which means $660 billion of public money is now under private management.

Adopting a more risk-friendly approach centered on alternative investments is a move Summers, as a veteran of Grosvenor Capital Management, is likely to feel comfortable with—which may well be one of the reasons Emanuel appointed him. Grosvenor has made its mark in the financial world primarily through managing alternative investments such as hedge funds-of-funds, with over $47 billion currently in alternative assets under management.

“The reality is, you have just as much, if not more exposure to risk and volatility in the market with investments in basic public securities than you do with alternative products meant to mitigate risk and limit volatility,” Summers told the Sun-Times. “That’s the business I was in — trying to do that for clients around the world.”

The Treasurer’s office did not respond to repeated requests for information and comment for this story.  

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