's failing public pension funds have funneled hundreds of millions of dollars into highly speculative investments that not only have failed to realize outsize returns but also saddled them with underperforming, long-term assets that can't be sold off, a Tribune investigation has found.
The investments, which involved buying equity stakes in businesses ranging from fast-food franchises in
grocery chain, were supposed to plug huge holes in pension fund coffers by yielding gains of up to 20 percent a year.
But a Tribune analysis of nearly 130 private equity and real estate investments made by four pension funds since 2000 found that nearly half have lost value so far. Of the $1.3 billion invested to date, the pension funds have seen just $60 million in added value on their balance sheets.
Had the funds used an equal amount to buy and hold a 30-year U.S. Treasury bond offered in 2000, they would have received $893 million in interest payments to date — and their principal investments would be secure.
Trustees of the city's pension funds made these risky calls because they were hoping to make more than the modest returns offered by government bonds. For years, they have been under tremendous pressure to make up for city agencies' inadequate contributions to the funds, which promise retirement security to the city's public employees.
In 2000, when the pension funds serving police, teachers, municipal workers and laborers were in relatively good shape, the trustees allocated just $47.8 million to investments in private equity and real estate. By 2006, as their funding levels began to drop, they increased those bets nearly sixfold, to $284 million.
Investment firms entrusted with the money, meanwhile, collected millions in fees despite failing to meet expectations.
"There's a real question as to whether Chicago's underfunded pensions can afford to be so heavily weighted in these investments," said Laurence Msall, president of the Civic Federation, a nonpartisan think tank that has been sounding the alarm on unfunded city and state pensions for years.
Asset managers contacted by the Tribune say the newspaper's analysis is based on a snapshot in time that doesn't reflect the true value of their enterprises. They say that although investment returns on private equity and real estate may see large losses during the first five years of a fund, profits quickly rise after that and typically beat out public markets by 5 percent or more.
Investment decisions made by pension board trustees have a major impact not only on current and former government workers but also on the fiscal health of the region, as failing pension funds are threatening to crush the city and state beneath tens of billions of dollars in debt.
The Tribune reported Wednesday that the eight pensions funded by city taxpayers are more than $20 billion underfunded, in no small part because promises made to workers weren't backed by adequate contributions. Unless something is done to shore up the funds, some are expected to go insolvent by 2019.
Unlike firms that oversee stocks and bonds, no benchmarks or procedures exist for pension boards to terminate real estate and private equity investment firms without incurring massive losses. What's more, the investments are not liquid, meaning funds cannot sell them off before they mature.
They also cost more to invest in. Administrative, consulting and asset manager expenses have nearly doubled since 2000 to $100 million a year for the eight city pension funds.
Some of the firms reaping rewards have connections to
. One was co-founded by Daley's former campaign manager David Wilhelm. Andre Rice, a Daley appointee to two public boards, runs another. City pension funds already have been criticized for investing about $60 million in a real estate firm co-founded by Daley nephew Robert Vanecko that has lost about $11 million in value, according to fund documents.
"Some pension board trustees put a lot of value on hiring Chicago-based firms, but for the sake of taxpayers and patrolmen, we need to be focused on absolute returns," said Mike Shields, a trustee of the police pension who has questioned how the funds have been operated.
Poor performance is no deterrent
Among the worst-performing private equity managers doing business with city retirement funds is a politically connected firm in which three Chicago funds invested $105 million.
The most recent pension fund documents show that those investments are now worth $12.6 million
than what the funds put into them, even as the firm collected more than $2.6 million in fees.
Chicago-based Muller & Monroe began landing business from city funds four months after forming its
Private Equity Fund-of-Funds, a limited partnership that invests in other private equity funds rather than in stand-alone businesses.
The city's police, municipal and teachers funds invested in the partnership in 2005. Together with smaller investments from the city firefighters fund, the State University Retirement System of Illinois and the Illinois Municipal Retirement Fund, they were the only investors in Muller & Monroe.
The funds were hoping for returns of about 16 percent annually. Instead, the $35 million in city pension money invested by the firm so far has fallen in value by $8.5 million.
Had the pension funds invested that amount in a 10-year U.S. Treasury note offered in 2005, they would have returned about $8.9 million in interest so far, while protecting the initial investment. That's a $17.4 million swing on the funds' balance sheets.
Rice, chief executive officer of Muller & Monroe, said the Tribune's analysis is premature and misleading.
"I disagree that you can tell what a fund is worth right now," Rice said. "As the companies we invest in grow and mature, they'll reach profitability. The data you are looking at is a blip in time."
Rice said he is confident the fund will reach profitability in the next year and eventually beat out public markets by 3 to 5 percent.
Aside from the astronomical returns the funds expected — more than four times greater than the returns of the S&P 500 at the time — investing with Muller & Monroe allowed pension fund trustees to fulfill a state-directed mandate to hire minority- and women-run firms. Rice is African-American.
The legislation was pushed by former state Sen.
, who collected more than $140,000 in campaign contributions from such firms afterward.
Among those who contributed to Jones was Rice, who staunchly supports the requirements for hiring minority firms. "White men had all the business," he said. "But did those firms have all the talent and all the know-how?"
Rice, whom Daley has appointed to two civic boards, said his years-long relationship with the mayor had nothing to do with his work for city pension funds. "No one at City Hall has ever made a call on my behalf suggesting or encouraging the funds to look at our firm," he said.
Despite lackluster returns from Muller & Monroe's first partnership, three of the city pension funds as well as the two state funds committed a second round of funding to the firm in 2007 and 2008, this time for its M2 Private Equity Fund-of-Funds.
Of the roughly $18.5 million invested in the M2 partnership so far, the city funds have seen the value of their investment drop about $2.3 million, according to fund documents. Rice said he expects the fund will return two times the funds' investment after five or six years.
Managers abandon safe strategies
Some pension experts argue that pension funds should be invested mainly in bonds and other fixed assets that guarantee returns while providing more protection for underlying investments. Some riskier equity investments may be included as a hedge against inflation.
That equation, however, can change when pensions aren't properly funded. Other than contributions from employees, investment income is the only way for pension funds to plug huge holes left by the city's inadequate payments.
State law restricted the investment strategies of most city pension funds until the late 1990s, when they were permitted to put more money into stocks and other equity investments in hopes of greater returns. The funds also started to invest more in private equity and real estate.
The idea was to capitalize on the growth potential of small businesses that would benefit from expert management teams, beefed-up accounting and general business acumen.
The Tribune found that Chicago's public pension fund money has gone to finance a bankrupt
printing company, an LA grocery chain once the focus of a gang-related federal indictment, a single-location
pharmacy that had been caught up in a 220-count Medicare fraud case, and dilapidated buildings in poverty-stricken neighborhoods.
Such choices may seem questionable, but asset managers and consultants working for the Chicago funds said these investments could beat out public stock markets by yielding returns of up to 20 percent. Pension funds and investment managers do not release information on how well individual investments perform.
professor Steven Kaplan studied the returns of private equity investments, he found that, on average, they do no better than the S&P 500, are subject to boom and bust periods, and depend heavily on the quality of managers running the limited partnerships.
"The perception out there is that private equity returns are better than returns in the public markets," Kaplan said. "But the data that's needed to make those determinations just aren't there. The best available information suggests that they are about equal to stocks."
SB Partners, a small private equity firm run by the former chief executive officer of Shorebank out of a single-family home in Holland, Mich., received $9.4 million from the municipal and laborers pension funds since 2000 while collecting more than $940,000 in fees.
It has invested in eight companies, including a string of Taco Bell franchises in Mississippi,
; a water-heater leasing company in
; and a single-location pharmacy in Denver.
At the end of 2009, SB had an annualized rate of return of about 4 percent, according to pension fund documents. David Shryock, who runs the firm, said returns have increased since then and are now around 6 percent, beating the S&P 500.
"We've done well in this fund," Shryock said. "We've done better than the public market."
But the S&P is a stock index made up of 500 companies worth $10 billion to $200 billion. Against public market indexes that track smaller companies, the firm hasn't done as well. The Russell 2000 Index, for example, has had annualized returns that are more than double SB's returns.
One Chicago pension fund that steered clear of private equity and real estate seems to be weathering the financial crisis better than other city funds.
By sticking to a portfolio of basic stocks and bonds, the Metropolitan Water Reclamation District pension fund's assets lost 14 percent of their value from 2005 to 2009, according to financial documents reviewed by the Tribune. Meanwhile, the teachers, municipal and laborers funds lost more than 20 percent, and the firefighters fund lost more than 33 percent.
"Our board is very conservative in its approach," said Susan Boutin, executive director of the water district's fund. "They feel they have a commitment to employees and retirees to not take on those kinds of risks."
The water district also spends less on consultants, asset managers and administrative expenses as a percentage of total assets than the other city funds.
Other funds are paying huge fees even for investments that have failed to meet their expectations. For instance, over the last seven years, the teachers and municipal pension funds have invested $30 million in the Chicago-based private equity firm Hispania Capital Partners. So far, the investment is worth $4.2 million less than what was put into it.
That's one of the worst performances found in the Tribune's analysis. But every year, because of management fees, Hispania's end of the deal grows. So far, it has received $2.3 million in fees.