You’ve probably heard of financial leverage. It’s the stuff that brought down once-mighty investment banks like Lehman Brothers and Bear Stearns.
But what is it? Why is it so dangerous?
And why is a San Diego County retirement fund using $2.5 billion worth of it?
You can read the answers here in my latest story on Voice of San Diego.
This is probably not a good idea:
The San Diego County Employees Retirement Association has adopted a new asset allocation that adds leverage to the $7.2 billion fund, Pensions & Investments reports. The leverage brings the total target allocation to 135 percent.
Pension funds are supposed to be boring, long-term investors. Not SDCERA. Taking on leverage is not a sure, safe way to save money for retirement. It is an aggressive, high risk strategy. It means you are essentially wagering more money than you have. Ask Lehman Brothers how that feels.
Leverage is a way of boosting returns by taking on more risk. The net expected return from this new strategy is now 10 percent (up from
8.25 8.5 percent), which is supposed to add an additional $1 billion over the next 10 years. But that’s if — and it’s a big if — if everything goes as planned.
A few years ago, the flavor of the month was hedge funds. Investment guru David Deutsch plowed 20 percent of the fund into hedge funds, including winners like Amaranth, which imploded when a single trader lost $6 billion in a bad bet on natural gas prices, and WG Trading, whose managers were arrested for fraud.
Instead of taking its lumps, however, SDCERA has spent two and a half years suing to get its money back from Amaranth. A federal judge in New York threw out SDCERA’s lawsuit against Amaranth today, but the pension says it will appeal.
Well, they don’t have Deutsch to blame anymore. He got booted out last year when the fund lost 25 percent. The board decided to outsource his job to Lee Partridge, a guy who didn’t even apply for the job and who stands to earn as much as $1.2 million.