Illinois Ponders Pension-Fund Moonshot: A $107 Billion Bond Sale

Ted

FYI: Lawmakers in Illinois are so desperate to shore up the state’s massively underfunded retirement system that they’re willing to entertain an eye-popping wager: Borrowing $107 billion and letting it ride in the financial markets.

The legislature’s personnel and pensions committee plans to meet on Jan. 30 to hear more about a proposal advanced by the State Universities Annuitants Association, according to Representative Robert Martwick. The group wants Illinois to issue the bonds this year to get its retirement system nearly fully funded, assuming that the state can make more on its investments than it will pay in interest.
Regards,
Ted
https://www.bloomberg.com/news/articles/2018-01-26/illinois-ponders-pension-fund-moonshot-a-107-billion-bond-sale?srnd=fixedincome

Old_Skeet

I would not be a buyer of these bonds. And, I am not sure many would want them! What say you?

Ted

Old_Skeet: They might appeal to the institutional investor.
Regards,
Ted

Old_Skeet

Hi @Ted,

Thanks for making comment.

Yep, I guess much like Puerto Rico did. If I remember correctly Franklin and Oppenheimer plus some others took some pretty good sizeable positions in Puerto Rico's tax free muni's. And, What happened? Puerto filed for bankruptcy with many not getting paid and the securities becoming just about worthless.

So, I can understand the Illinois' pension funds wanting the state to make good on pledged pensions; but, they are wanting investors to assume liability through the capital markets by buying questionable securities that have a good chance of going into default. Then what? Another government bailout?

For me, I going to stay as far away from this type of investing as I can get.

msf

If you're really interested in this type of security, here's a good primer I found from Orrick Herrington & Sutcliffe: An Introduction to Pension Obligation Bonds and Other Post-Employment Benefits.

I would have thought that governments could segregate the market investments and use them as securities for the bonds (much as CEFs use their portfolios as securities for the bonds/preferred stock they circulate to achieve leverage). I was wrong, but there are still some other ways to back up the debt (albeit not often used, and probably not likely here).

Regarding Franklin and Oppenheimer, I don't think it's fair to lump them together. Franklin had a single fund that was designed to be tax free in every state. So it had to invest in munis from territories (PR, US VI, Guam, etc.), and the elephant in the room is Puerto Rico. No real way around investing in the territories, as clearly disclosed in the prospectus of the fund designed to do that.

Oppenheimer Rochester funds take on risk simply for the sake of juicing returns. So they load their state-specific funds with territory bonds, notably PR. ISTM this is very different. Check out the top ten funds (by percentage of AUM) invested in PR in mid 2015: the Franklin Double Tax Free Income Fund (FPRTX), followed by nine Oppenheimer Rochester funds, mostly single state, with a couple of national muni funds:
https://www.usatoday.com/story/money/markets/2015/06/30/puerto-rico-bond-funds-exposure/29515913/

Old_Skeet

@mfs,

Thanks for making comment.

A double tax free muni fund that I owned at one time was Franklin's North Carolina Tax Free Muni Fund. And, guess what? It held Puerto Rico bonds. And, I sold it long before Puerto Rico became a default issue based upon my advisor's advice. Indeed, he kept me out of that rat trap.

So yes, by me, Frankin goes in the stew pot with the rest with respect to Puerto Rico.

msf

I don't think you appreciate the nature of FPRTX. This was a fund that was double tax free in all 50 states. At the risk of sounding repetitive, the only way to accomplish this is to invest exclusively in munis issued by territories. This must load up on Puerto Rico - since it must own only territories, and pragmatically most of those bonds are from PR.

That's very different from a single state fund, that's allowed, in fact expected, to have the vast majority of its bonds tax-exempt in just one state. This doesn't preclude these funds from bulking up on territory bonds, but it doesn't require them to, unlike FPRTX.

As it turns out, in the past decade, FXCNX never exceeded 20% in territory bonds, generally peaking around 18% between 2010 and 2012. In 2015 it had dropped down to 5% or so. Contrast that with the 2015 holdings of the Oppenheimer Rochester funds in the link I provided (some 30%+, all nine over 18%).

To put these numbers in perspective, I spot checked other NC long muni funds in 2012 (links are to SEC filings):
FXCNX (2/2012): 18.3%
EVNCX (2/2012) 16.2%
MSNCX (3/2012) 9.6% (if I added right)
FLNCX (5/2012) 1.25% (my arithmetic, again)
OPNCX (3/2012) 40.6%

From the Oppenheimer Annual Report: "Securities of the Commonwealth of Puerto Rico, which are exempt from federal, state and local income taxes, represented 40.6% of the Fund’s net assets as of March 30, 2012, and contributed favorably to the Fund’s total return this reporting period."

Sure, Franklin is at the high end of the "normal" range for territory holdings, along with Eaton Vance. But Oppenheimer Rochester is in a class of its own - in the risks it takes, and in how it flaunts this (at least in good times). Many people do not seem to recognize the outsized risks this family takes.

Old_Skeet

@mfs,

From memory your research is believed, by me, to be good. The three North Carolina Muni funds I held were FXNCX (Franklin) ... ETNCX (Eaton Vance) ... and, you guessed it OPNCX (Oppenheimer).

And, yes I let all three of them go because of their Puerto Rico positions plus three other national muni funds as well. My advisor saved me a good bit of grief as the nationals (I held) were also loaded with Puerto Rico bonds as well.

Moving on ... tax free Illinois bonds have no interest to me at all "whatsoever." From my perspective they are an investment hazard just as Puerto Rico became to be. Linked below is an article that supports this thinking.

http://www.chicagotribune.com/business/columnists/ct-illinois-chicago-municipal-bonds-junk-0611-biz-20170609-story.html

msf

Without even reading the link, I agree with you about Ill. (perhaps an apt abbreviation). When BobC suggested NEARX, I expressed concern about its fairly high percentage of Illinois bonds. He felt that the manager was good at monitoring risk, and I do see that the Illinois holdings have been reduced to 4.34% as of the latest semiannual report.

(Performance has been another story; over the past three years, the supposedly more conservative VMLUX has done better, but I digress.)