When the Philadelphia Board of Pensions and Retirement hired Apollo Global Management to invest tens of millions of dollars in junk bonds in 2013, the fund's overseers said they were making a careful bet.
Sure, the bond issuers were risky-looking private companies. But the city could collect interest they paid as cash each year, unlike with most hedge funds and "alternative assets."
Apollo's founders include Josh Harris, lead owner of the NBA's woeful 76ers. Which inspired the inevitable cracks about the woefully underfunded pension system needing a rebuilding year.
Last year, Apollo's Philadelphia portfolio lost $15 million in value (falling to about $84 million), trailing junk-bond debt benchmarks by 15 percent and bringing its losses since the city invested to 5 percent. That made Apollo a drag on the city pension system's target of 7.8 percent profits each year. (It has since been lowered a bit.)
The city needs every buck it can squeeze from its investments. Even with payroll contributions from city workers, who are outnumbered by retirees, pension investments are so underfunded that taxpayers have to add more than $600 million a year - one-sixth of the city budget - to make sure checks will go out to retired police and other city workers until they die.
Even with Apollo's losses, the city continued to pay that firm about $50,000 a month in management fees, city records show.
Why are they still around? "We're not happy with their performance so far," city Finance Director Rob DuBow told me.
But, "Apollo has a good track record. They have been through cycles like this," added Brad Woolworth, the pension system's chief investment officer.
Woolworth blamed the Apollo fund's recent drop on its concentration on small- and mid-market energy companies jammed by the collapse of oil prices.
"It's not fun," but, so far, the junk-rated companies in the fund are still making their debt payments, and Philadelphia is still collecting 7 percent yearly returns
on its assets, in cash," Woolworth added. (The cash payments were added to bond-valuation losses in calculating Apollo's overall 15 percent loss.)
If the city dumped Apollo, it would have to sell the bonds at today's low prices, write off the loss, and lose the interest income, pensions director Fran Bielli noted.
If that sounds as if Apollo gets a pass, it turns out that underperforming managers don't have guaranteed employment in Philadelphia, any more than underperforming NBA prospects.
The city fired four pension managers last week, terminating accounts with the ESG, Blue Harbour, Archview, and Kildonan Castle fund groups. All lost money, while collecting fees totaling more than $1 million in the first nine months. "They didn't have the returns we needed," DuBow told me.
Three other funds - run by the Axonic Capital, 400 Capital Management, and Elizabeth Park Capital Management investment groups - were given a month to renegotiate their Philadelphia fee agreements.
These had better returns, but "their fees are high" compared with performance, Woolworth said.
Hedge funds generally "are not performing as we expected," and that's why the city has been selling them, Bielli said.
As it cuts back on hedge funds, Philadelphia has been investing more in low-fee indexed funds. About 40 percent of the city's money is now run through index portfolios managed by RhumbLine Advisers of Boston and Northern Trust Co. of Chicago, DuBow noted.
RhumbLine is charging as little as 1 basis point - that's 1 percent of 1 percentage point - for running an indexed portfolio of U.S. stocks.
"We are hedging our returns elsewhere, for a better price," Bielli said.