Thursday, September 2, 2010

How Risky Are Illinois Pension Funds?

On the 8/28/2010 Radio Show, we used the June 11th article in the Medill Reports by Alexandra Harris on the Illinois Teacher's Retirement System use of derivatives and investment diversification methodology which has made it the fourth riskiest pension fund in the Untied States.  We did not spend a lot of time on the subject given the amount of information we try to cover during the show and after we had researched the information earlier in the week, an article by Doug Finke was published in the State Journal-Register on the pension system and the fact they are selling $3 billion of assets to make pension payments and the State University Retirement System was selling $1.2 billion.  The Illinois Investment Board may also sell $840 million of assets to pay benefits for the state employee's, General Assembly, and Judge's retirement systems.  In the S J-R article, the Teacher's Retirement System spokesperson attributed the need to sell assets to the failure of the State to make its required contributions to the retirement system and the lost opportunity from not having the money to invest.

In the Medill Reports article, Alexandra Harris not only details the prior year losses in 2008 ($4.4 billion or 5%) and 2009 (22.3% loss) of which in 2009 the derivatives loss alone was $381, 367, 366.  Harris had a list of investments as of March 31, 2010, received under a Freedom of Information request and the Illinois Auditor General's audit report for Fiscal Year 2009 to obtain information on the investments and had them reviewed by professionals knowledgeable about derivatives and pension fund investing.  On page 52 of that audit report, you can see the projected allocations for investment for 2009 and what they were in 2008.  Harris indicates that the pension system has adopted a riskier investment allocation beginning in the 1990's, which would have been approximately the time the State adopted a ramped tier system of increasing payments by the State to reduce underfunding of State pension funds.  However, this funding formula has been delayed or suspended more than once in the intervening years and even the issuance of pension bonds in 2010 was denied by the General Assembly.  Consequently, the Teacher's Retirement System is 60.9% underfunded.

In the Medill Reports article, Teacher's Retirement System spokespeople indicated there would be a profit in 2010 from using derivatives, but the author's professional reviewers of the investment balance sheet and listing of investments were seeing a loss of approximately $515 million.

The Medill Reports article also attributes the risky investing style to a methodology of the Yale Endowment, which got itself in trouble in 2008 with its illiquid style of investing.  However, if you look at the allocation in 2009 of the Yale Endowment on page 7, you will see that the Illinois Teacher's Retirement System allocation of investments is quite divergent from the Yale Endowment and far riskier, even without considering its dependence on derivatives.  The Teacher's Retirement System has eight (8) pages of derivative investments, far more U.S. and international equities and far less Absolute Return, Real Return (only 6 investments), and Real Assets.  They are not comparable.  What is clear is that the Teacher's Retirement System is engaged, and has been engaged, for several years in risky catch-up investing that paid off through 2007 and is now clearly dangerous.

Derivatives were a primarily cause of the current financial crisis.  The use of derivatives and the type of derivatives being used by the Teacher's Retirement Fund are not marginal hedging of other investments.  They are substantial bets of inflation in regional parts of the world, long term Treasury yields, and CDS on corporate and sovereign debt of foreign nations.  This is more appropriate for a major bank trading desk and we have seen the destruction that can bring and the cost to society.  It is not appropriate for a pension fund.

To see how the other pension funds are invested and doing, go to the Illinois Auditor General and look at the audit reports under Retirement Systems.
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