Dallas pension investments have taken a hit. But the fund says that’s not the whole story

Two months ago, news of the Dallas Police and Fire Pension system netting a 2% return over 10 years, one of the poorest performances in the state, rankled most anyone who cared about how public safety officers would fare post-retirement.
It’s been seven years since the Legislature stepped in to rescue the fund from the brink of collapse and Months since a rift between the city and the pension system over who gets to have the final say in authorizing a plan to solve the shortfall became public.
The news of the 2% return was a clear sign the fund hadn’t improved, raising questions of whether the pension system was making the type of financial choices reminiscent of the actions that put it in dire straits in the first place.
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Poor performance is a touchy subject when it comes to the DPFP, especially now that the city is on track to direct more dollars to fill a $3 billion pension hole. On Thursday, the ad hoc committee on pensions is expected to discuss alternative revenue streams to tackle the shortfall. They will also discuss the study from a third-party investment firm, Commerce Street, the city hired to gauge if DPFP and the non-uniformed Employees Retirement Fund adequately manage their assets.
Ultimately, it’s the taxpayers who foot the bill. If the fund performs well, taxpayers pay less.
Staffers at the pension system believe the 2% return doesn’t tell the complete story. “I think if you look at (the 10-year return), it shows that things aren’t getting better,” said Ryan Wagner, the pension system’s chief financial officer. “They are getting better. They have.”
Pension officials told The Dallas Morning News they are expecting their 10-year investment performance to shoot up close to 5% in the next two years, and that’s primarily because a lot of their bad investments that were reflected in the 10-year range will drop off.
They say the fund “was positioned to manage new funds the same way a high-performing pension plan would.”
How the pension system manages its fund is likely reflected in the Commerce Street report.
A memo to the ad hoc committee had brief takeaways from the report.
DPFP’s performance, over time, could “exceed appropriate benchmarks and the median of DPFPS’s peers,” the report said. The pension system is currently 39% funded and beset by hard-to-exit legacy assets impacting the fund’s investment return. But “improved risk-adjusted returns are needed to lower City contributions and increase funded status,” the report said.
On the other hand, the Employees’ Retirement Fund, which is over 70% funded, may need to invest more in private markets. ERF would also need to improve asset manager selection for better returns.
Most notably, the report also recommended the city hire a new firm to recurrently provide reports of how the pension funds are performing, especially compared to its peers in cities such as Houston and Austin. The firm would also have to “improve the City’s understanding of pensions.”
Jean-Pierre Aubry, with the Center for Retirement Research, said based on figures from 2022, the pension fund’s portfolios in index funds and bonds, as well as most other asset classes, had a reasonable performance — all except for their private equity portfolio.
“It just looks to me like private equity and real estate over the past 10 years — whatever they’ve been holding — has not worked out right for them,” Aubry said, adding the private equity and real estate investments were a drag on the system’s performance.
Executive Director Kelly Gottschalk said the pension system was still saddled with investments made between 2005 and 2008 that are incredibly hard to exit.
An issue with all of these investments is the previous leadership at the pension system, composed mainly of police officers and firefighters, bought real estate and paid far exceeded what the property was actually worth.
Not only was the board overpaying, it was buying more.
Acres of empty land in rural Idaho and Colorado. A wine resort in California. Luxury homes in Hawaii.
“(The board) was calling special meetings more frequently, buying properties and there was no foresight — is this commitment level appropriate for a plan of our size?” Gottschalk said.
“Legacy assets continue to contribute to underperformance,” said an Aug. 21 city memo, with takeaways from the Commerce Street report.
Between 2005 and 2008, the fund committed $1.9 billion in the private market. This means the fund promised to pay for projects whose bills could increase years later.
In the worst year — 2006 — the fund committed $833 million in various private equity and real estate portfolios. Then, the housing market crashed in 2008. Properties suffered. The system began pouring more dollars to save the investments.
Another strain on the pension system came from the Deferred Retirement Option Plan, where retired officers could continue working and have their benefits routed into a separate account with a guaranteed interest rate. In 2016, DROP accounted for 58% of the pension system’s assets. It prompted retirees, worried about losing access to their drop accounts amid the pension’s perils, to make a “run-on-the-bank,” withdrawing $600 million.
Withdrawals were frozen that same year after Mayor Mike Rawlings went to court.
According to May figures provided by DPFP, the pension system’s allocation to real estate now sits at 8%. Private equity sits at 10.5%. Wagner said the pension system’s goal was to reduce each allocation to 5%.
Wagner said the previous board and staff tied up two-thirds of DPFP’s plan in private markets over four years. Starting in 2013, the pension fund began reappraising all its investments, and the loss in value came as a hit to its accounting book.
For the past seven years, the pension has been steadily selling off problematic assets, while trying to recover as many dollars as it can. So far it has sold off assets to the tune of $1.4 billion.
At present, a big portion of its hard-to-exit-legacy assets are locked in two private equities, Dallas-based Lone star and Huff Energy Fund, as well as a real estate portfolio managed by AEW. It was managed by CDK Realty Advisors, which was raided by the Federal Bureau of Investigation.
Private equity managers typically buy companies and rarely cede control to investors. In a regular stock market scenario, an investor has the flexibility to tweak asset allocations based on how the market is doing. That’s not the case with a private equity manager that also owns the portfolio of the companies it’s controlling.
The problem is DPFP had nearly a 50% stake in one (Lone star) and about 20% in another (Huff Energy Fund).
“We should have never been a 50% investor in a private equity fund,” Wagner said, adding the pension system was putting controls in place to avoid situations where it was stuck with a private equity fund.
“We want to make sure we’re not more than 5% or 10% of a fund because it ensures that there’s other institutional investors that are willing to invest with that manager with the right confidence and we are not overexposed to one manager,” he said.
Pension officials were fairly optimistic about the real estate portfolio managed by AEW. The sale of the Union, a mixed-use building and former DPFP headquarters, yielded $51 million of profit on the original investment of $21 million, Wagner said.
“We made the most out of the situation,” Wagner said.
The pension system plans to exit the legacy investments affecting its investment performance and build a portfolio yielding a 6.5% return per year.
Hank Kim, executive director at the National Conference of Public Employee Retirement, said DPFP’s current allocations indicate it is taking a rather risk-averse approach in its investments, likely due to its past experience with private markets.
The pension system had significantly lowered its stake in private markets and increased reliance on the stock market, an example of a traditional pension plan.
That’s not the route that a lot of public plans around the U.S. are taking these days, Kim said. In the past, investment teams believed in putting 60% of their investments in public equity, 35% in fixed income or bonds and the remaining 5% in alternative assets like private equities.
“That model does not exist anymore,” Kim said.
The pension fund currently contributes roughly 25% in private markets, which Kim said is less than typical public plans its size. In most cases, a pension system comparable to DPFP may put 40% in private markets.
“But given where they came from, particularly relative to real estate, I can understand why,” Kim said.
That’s not to say the pension system doesn’t have plans to once again invest in private entities. Pension officials hired Albourne, an investment advisory firm, to help the system “do some of the stuff that wasn’t done that first time and build a program the right way.”
There are two critical things to understand about the pension. First, it has a cash flow problem. More money is leaving the pension system to pay benefits than coming in. Wagner said the system needs close to $10 million more every month to close the gap.
Second, because the pension system’s portfolio is overexposed to risky investments that are hard to exit and has a lot of money tied up in private markets, the fund didn’t have the money to buy good public equities and fixed-income options.
This is where the city comes in.
“The quicker you get money into the pension plan so that it can invest it and let the markets do its magic to increase the returns on that, the better it is for the pension plan,” Kim said.
That’s part of the pension system’s rationale in seeking a plan where the city ramps up funding in the next three years.
But the city, which has built this year’s budget around the pension system, says it can only afford to get to the “actuarially determined” contributions in five years. Actuarially determined contributions, unlike fixed rate contributions, are flexible dollar amounts dependent on how fast the pension is funded and how well its investments perform. If the pension does well, the city could pay less in contributions.
Ramping up extra contributions in three years may force the city to cut services.
To add to that, the city says it has prioritized public safety expenses in this year’s budget and has given uniformed officers a 7% raise in salaries to stay competitive in the market.
A report from Cheiron, an actuarial firm hired to recommend payment plans, said either the five- or the three-year program would get the pension where it needs to be — solvent in 30 years.
The final plan needs to reach the Pension Review Board before Nov. 1. But the road appears bumpy.
Trust issues have mired the relationship between pension and city officials. They’ve disagreed on the scale of cost-of-living adjustments to benefits. They disagree on the governing structure, which could give the city greater oversight.
And now there’s a lawsuit.
Earlier this month, DPFP said it was taking the city to state court to settle once and for all on who gets to be the final arbiter of adopting the funding plan. In a recent letter from DPFP Board Chair Nick Merrick, DPFP has expressed discontent with the increase in the city’s contribution to the Employees’ Retirement Fund, which services non-uniformed employees.
ERF employees received cost-of-living adjustments (COLA) because their pension fund is 70% funded. DPFP, at 39%, is unable to get COLA. State law mandates that pension funds have a more than 70% funding level to access increases.