Inside Bright Start fund's flameout

How Giannoulias dealt with college saving plan's mounting losses during 2008 market meltdown


By Jeff Coen and Todd Lighty, Tribune reporters

As the economy began its meltdown in 2008, Illinois Treasurer Alexi Giannoulias was faced with a dilemma over the state's college savings plan for families.

Giannoulias had made revitalizing the underperforming program a key component in his successful 2006 campaign, and the investment firm he selected to turn around Bright Start was making positive changes. But the fund manager also made a decision to heavily invest in volatile securities tied to the housing market.

Documents and e-mails recently obtained by the Tribune under the state's open records law show the rookie treasurer and his staff were concerned early on about the aggressive move by OppenheimerFunds Inc. in what was supposed to be a more conservative fund in the Bright Start program.

But at each turn Giannoulias stuck with the firm's strategy, even as the housing market soured and losses accelerated.

Now, with Giannoulias locked in a tight U.S. Senate race against Republican Rep. Mark Kirk, the $150 million loss in the Bright Start program has become a major campaign issue. Republican television ads question the competence of Giannoulias, a one-time officeholder whose financial expertise was based on a short tenure at his family's failed bank.

Kirk — who once faulted Oppenheimer and not Giannoulias — says his campaign's review of the public records shows Giannoulias mismanaged the Core Plus Fixed Income Strategy fund, which at one time held 15 percent of the money invested in Bright Start.

"Before documents surfaced showing that Alexi Giannoulias had information about the poor performance of Core Plus and urged Illinois families to keep investing anyway, the congressman was willing to give him the benefit of the doubt," said Kirk spokeswoman Kirsten Kukowski. "Now that the facts have come to light, voters need to know about the gross mismanagement by Alexi Giannoulias and the treasurer's office."

In the past, Giannoulias has been quick to blame Oppenheimer for mismanaging the fund but has offered little explanation about his role in overseeing the fund — including when he first knew about Core Plus losses and what he did about it.

In a recent interview with the Tribune, Giannoulias reiterated that he was one of the first officials to confront Oppenheimer about the losses. He said he stayed the course based on advice from Oppenheimer managers, his own staff and an outside financial consultant.

"Our office was concerned, upset, with the performance of that fund and wanted an explanation," Giannoulias said. "We pressed hard on Oppenheimer. They continued to reassure our office that their strategy was appropriately positioned especially when the markets restabilized."

Giannoulias said his office moved quickly to recover about $77 million for more than 65,000 Bright Start investors in a settlement with Oppenheimer, which admitted no wrongdoing. He also said he took Bright Start from one of the worst-ranked programs in the country to among the top-rated by national publications.

Analysts said the volatility of the market in 2008 caught many financial professionals off-guard. They also said that among states with exposure to such funds managed by Oppenheimer, none reacted any faster than Illinois.
"Plenty of people more astute than the state treasurer were under the impression things were relatively safe," said college savings expert Kevin McKinley, owner of McKinley Money, a Wisconsin-based financial advice and management company. "It was very difficult for anybody to see how bad things got and how quickly things got bad, regardless whether it was Bright Start, Oppenheimer funds or whatever."

Like many college savings programs of its kind, Bright Start offers investment choices that vary depending on the child's age.

Families with younger children tend to invest in the program's higher-risk funds in search of higher rewards, since they have more time to ride the ups and downs of the market. Families with children nearing college age often tend toward safer funds to preserve their savings — not unlike people nearing retirement who move their 401(k) plan toward more conservative funds.

The program's Core Plus fund was considered more conservative because it was supposed to be based in government bonds and other less-volatile investments. But in late 2007, Oppenheimer moved more of the Core Plus investments into mortgage-backed securities in pursuit of a better rate of return, which had the effect of adding more risk.

That potential risk was greater for parents of children nearing college age, because Oppenheimer was placing more of their money into Core Plus.

In early 2008, the risk of mortgage-backed securities — which depend on a healthy real estate market — came into sharper focus because of the role they played in the collapse of global investment giant Bear Stearns.

Giannoulias' office asked Oppenheimer for an accounting of Bright Start's financial performance as it began to lose value. In a May 6 e-mail to Oppenheimer managers, Shirley Yang, the treasurer's director of college savings programs, said Giannoulias would attend a meeting with them on May 19, 2008, in the treasurer's downtown Chicago office.

Giannoulias was interested in the "recent underperformance relative to our benchmarks" and "how Oppenheimer will be addressing performance going forward in order to 'turn the ship around,'" the e-mail said.

In an e-mail days after the meeting with Giannoulias, Yang specifically noted concerns about Core Plus and asked Oppenheimer to explore how other college savings plans were using such fixed-income funds.

"The intuition we have is that most consumers think of Fixed Income as very conservative which may or may not be the case," Yang wrote in the May 23 e-mail.

Things worsened over the summer, both for the economy and for Core Plus.

In an Aug. 19 e-mail, Yang wrote to Oppenheimer managers, "I think the bottom line is we're having a difficult time answering the question of 'why should we stick with Core Plus?'"

Two days later, the records show, the treasurer's staff prepared a briefing for Giannoulias that included the idea of taking Core Plus in a more conservative direction. Staff materials prepared for the meeting noted that "getting out now would lock in substantial losses that may be difficult to overcome."

No changes were made to the Core Plus allocation. Giannoulias said that's because, like Oppenheimer, his office's outside consultant also advised against bailing out of the fund.

In September, the U.S. government announced it would seize mortgage finance giants Fannie Mae and Freddie Mac. Exposure to mortgage-backed securities sent major investment firms into nosedives, and Core Plus losses ballooned to nearly 9 percent for the month.

Losses were accelerating in October, but in an Oct. 29 letter to Bright Start account holders, Giannoulias sought to calm concerns over the crisis in the financial markets. He noted the savings program was well-diversified. Without mentioning Core Plus, he wrote that the decline of fixed-income funds could be reversed "when credit markets normalize."

Giannoulias said he could not guarantee improvement but warned that by "making an emotional decision based on a short-term outlook, you could jeopardize your future college savings objectives."

Losses continued to mount, however, and the treasurer's office met again with Oppenheimer. Yang said in an interview Wednesday that was the point when the treasurer's staff realized there would be no rebound.

"In November we hit the low point," she said. "We said we'd had enough. (Giannoulias) basically said, 'We're done.'"

The treasurer's office directed Oppenheimer to divert any new contributions from Core Plus to safer U.S. Treasury bonds.

By the time that change took effect on Dec. 4, Core Plus had lost 38 percent of its value for the year. Over the same period, other funds of its type showed about a 5 percent return.

Giannoulias said in an interview that losses were made worse because the fund was invested in even riskier credit-default swaps, which he said was hidden from his office. Oppenheimer declined to comment for this story.

"It breaks my heart to hear that people have lost money in any fund," Giannoulias said. "But what took place with the markets was devastating to a lot of individuals and a lot of businesses."

Andrew Stoltmann, a Chicago securities lawyer who represented families that lost money in Bright Start, said his clients had little choice but to take the settlement offer — in part because their children were about to go to college.

"Can Alexi Giannoulias be faulted for not figuring this out sooner? Sure," said Stoltmann. But, he said, "even some of the best minds on Wall Street had a hard time figuring it out."

jcoen@tribune.com

tlighty@tribune.com

http://www.chicagotribune.com/news/elections/ct-met-senate-bright-start-20101013,0,6925166,full.story