. . . the Wall Street Journal is covering.
AUSTIN, Texas -- On the 13th floor of a sleek downtown office building here, the trading desks are manned overnight. The chief investment officer favors cowboy boots made of elephant skin. And when a bet pays off, even the secretaries can be entitled to bonuses.
The office's occupant isn't a highflying hedge fund but the Teacher Retirement System of . . .
. . . Texas, a public pension fund with 1.3 million members including schoolteachers, bus drivers and cafeteria workers across the state.
It is a sign of the times. Numerous pension funds are still struggling to make up investment losses from the financial crisis. Rather than reduce risks in the wake of those declines, many are getting aggressive. They are loading up on private equity and other nontraditional investments that promise high, steady returns in the face of low interest rates and a volatile stock market.
The $114 billion Texas fund has hit the trend particularly hard. It now boasts some of the splashiest bets in the industry, having committeed $30 billion to private equity, real estate and other so-called alternatives since early 2008. That makes it the biggest investor among the 10 largest U.S. public pensions . . . .
. . . .
Even in Texas, there isn't exactly consensus. Critics worry that the teachers' benefits are leaning too heavily on the esoteric investments, which can be less liquid and less transparent than stocks and bonds. Another sticking point is the fund's generous bonus culture -- a contrast against the pensioners, who haven't seen a cost-of-living raise in more than a decade.
. . . .
With so much riding on returns, [Britt Harris, the agency's chief investment officer,] has created an investment operation that looks and feels more like a giant hedge fund than a government agency. The office lobby buzzes with a flat-screen television that hangs next to photos of school children. Two of the fund's traders work into the night from a windowless room, following the market in Asia and Europe. Staff -- including secretaries -- can score annual bonuses provided the pension beats its peers by just a small fraction.
. . . . Last year, [Mr. Harris] was rewarded by the fund with a bonus totaling $483,753. . . .
. . . .
For decades, the Teacher Retirement System favored a mild brew of stocks and bonds. But starting in 2000, Gov. Rick Perry, a Republican, put real-estate developers and other investors on the pension system's board. five of the nine current trustees are investment professionals.
"We had to have a more progressive system of investing if retirees were ever going to get a cost-of-living increase," says Linus Wright, a former pension board member and former superintendent of the Dallas schools.
Between 2005 and 2007, as Texas and other states were ratching up their private-equity investments, state legislatures passed laws preventing certain information about the holdings from being disclosed to the public. Some private-equity firms insisted on these measures before approving investments from pension funds, says William Kelly, a partner at Nixon Peabody LLP . . . .
. . . .
During the financial crisis, the Texas teachers fund showed its mettle by making investments that many pension funds couldn't stomach.
As the credit crisis escalated in late 2008, the Texas pension board authorized an investment of up to $5 billion in inexpensive, high-yielding debt.
. . . .
[Former State Senator Steve Ogden] tried to convince lawmakers to reconsider the teachers' investment strategy. Instead, officials opted to extend it to at least 2018 while voting to allow the fund to double its hedge-fund investments.
"They found no smoking gun to convince them to cancel the program," recalls Mr. Ogden.
The pension board also took steps to reduce the red tape [read adult supervision] in the investment process, giving its senior investment staff "quick-strike authority" to invest up to $1 billion without board approval.
. . . .
[Despite some good investments,] doubters wonder if the strategy is sustainable. "They may think they are the smartest and best investors, but this system cannot work in the long term," says former Rep. Warren Chisum . . . .
(Michael Corkery, "Pensions Bet Big With Private Equity," wsj.com, January 24, 2013 (emphasis added))
The expensive, high-risk TRS investment approach is dumb and dangerous.
It invites financial corruption. Investing through regulated exchanges minimizes the temptation. Investing in one-off deals with good old boys in Houston or Dallas (or Cleveland or New York, for that matter) is an invitation to chicanery. Most are more or less honest, but if the marginal cost of talking some pension-fund board member out of a billion dollars is a teeny-tiny little quid pro quo -- a sweet deal on a land deal, fer instance, or a cushy job on the other side of the revolving door -- what's the harm? It will happen. Repeatedly.
It invites political corruption. The board and investment professionals will regularly sit across the table from politically well-connected promoters with can't-fail projects. The TRS will know through the mysterious ways that things like that are known that the governor really wants the deal to go through. Or the lieutenant governor. Or the chairman of the education committee. Or another member of the TRS board. And the deal will go through. Financial due diligence will take a back seat to political due diligence. Count on it.
It's based on hubris. Few investment managers beat the market over the long haul. The TRS may have done so for the past few years, though the lack of transparency and liquidity in hedge-fund investments makes it devilishly difficult to know for sure. But the TRS is not in the short-term business. High-risk investments sometimes work and sometimes fail. When they fail, losses -- often highly leveraged at the hedge-fund level -- can be spectacular.
It's too secretive at the deal-making level. Who are these people who are get hard-earned Texas money? What are they doing with the money? These matters are, sorry to say, none of your darn business.
It's financially nontransparent. How much is a private hedge-fund deal worth? Who knows? And if it goes bad, what's to keep the TRS from carrying the deal on its books forever at the original value, to avoid recognizing the loss?
It's too illiquid. Getting out of hedge-fund deals is not easy. There aren't many potential buyers. And the investment contracts usually restrict sales and withdrawals. The operative principle in the hedge-fund bidness, as in Las Vegas, is "let it ride."
Too many people are getting too rich off the teachers' money. The TRS tosses bonuses around like biscuits at a Cotton Patch franchise. The hedge-fund operators also take big cuts out of the original investments and the subsequent income and gains, if any. Lots of insiders are getting way rich. None of them is a teacher.
There are better alternatives. One guy with a laptop computer and a one-page set of investment guidelines could run the TRS investment account. All he needs to do is spread the money around a diversified set of low-cost index funds. Vanguard. Fidelity. You name it. Hire a second guy to look over his shoulder. And hire a third guy to keep the records. There you have it. Three guys. Millions saved. Risks minimized.
The TRS investment team is Enron disguised as a state agency. The scheme will work until the day it stops working.
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