Why Pa. Taxpayers Will Have To Cough Up $4 Billion

by: Brendan Magee

2/7/13

In Sunday January 27th's edition of the Philadelphia Inquirer, Joseph N. Di Stefano, reported that Pennsylvania's taxpayer's contribution to the state's pension fund is going to increase from $1.6 billion to $4 billion within four years. So what's one of the major reasons for the increase? Answer, the Pennsylvania State Employees Retirement System (SERS) board of directors not knowing the difference between gambling and speculating with money vs. prudently investing it.


In 2006 SERS gave $3 billion in taxpayer money to six private investment firms in an effort to outperfrom sagging bond and stock markets. They also needed to find a way to pay for increases to the pension benefit which was enacted by Gov. Tom Ridge, but who failed to provide the funding for such an increase.


So first things first, What is a hedge fund? It's an aggressively managed portfolio of investments and unlike your typical mutual fund they are not subject to the same level of regulations from the Securities and Exchange Commission. Their pitch is they are designed to generate above market rates of return. They claim to have a special or sophisticated ability to know in advance where your money should or shouldn't be to outperfrorm the market. In other words you could substitute the word speculate for aggressively managed because in order to outperform the market you would have to be able to predict the future. 

Pa. believed or wanted to believe that there were special frims out there that could do just that. They were so impressed that they paid one firm Arden Asset Management $20 million of taxpayer money to identify which hedge funds they should use for their pension portfolio from 2006 through 2012.
 

So the first step SERS took down the slippery slope of gambling and speculation was the failure to realize that in order to outperfrom the market, their portfolio (the taxpayer's money) would exposed to strategies that were in essence gambling and speculation. They paid for the privilege of getting a seat at the blackjack table with taxpayer money.


The second step was allowing someone to continually roll the dice with the pension's money. A hedge fund's performance is based on that fund manager knowing in advance which way the market is going and having their money properly allocated before the market reacts. The state had no idea that all the available infromation has already been factored into market prices. They failed to grasp that only unknowable and unpredictable information and events that will take place in the future and how the world's population reacts to those events will determine market prices going forward.  How in the world could anyone claim to have this ability? How in the world would anyone believe anyone who claimed to have this unique insight?


As is the case with most gambling, the results of the hedge fund managers was not very profitable. Between mid 2007 to mid 2012 the average hedge fund according to the Bloomberg Hedge Fund Index lost 10 cents on every dollar invested. Arden Asset Management fared better than the average hedge fund in that they gained 2 cents for every dollar invested, but that was far below the 7.5% projected and needed by the pension to meet its obligations.


 To compound, the problem the state anounced it was liquidating its hedge fund position. Another way and what would be the honorable thing for the state to tell the taxpayer is, The STATE BOUGHT HIGH AND NOW IS NOW SELLING LOW. As far as the state is concerned that's no problem,the taxpayer is more than willing to make up for the shortfall($4 billion).  The irony here is that the state anounced it will give Arden another $150 million in taxpayer money to invest.


I say the taxpayer has every right to be upset about how the state is mismanging their pension fund. After all it's the taxpayer who ultimately pays the price. However, the solution for the state and taxpayer is an Investor Coach. A coach would be an advocate not only for the state but the taxpayer as well. For example, the coach could create an agreement with SERS that they are not allowed to engage in any strategy that is consistent with gambling and speculation. Every transaction has to be anounced to the public in advance. There would also be strict fines placed on any governemnt official who engaged in or allowed for any gambling or speculation activities with Pa.'s pension money. After all, where is the incentive to disengage in a dysfunctional behavior if there is no penalty?



Brendan Magee is the founder and president of Inevitable Wealth Coaching. With questions or comments call 610-446-4322 or e-mail to brendan@coachgee.com