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New York Common Fund Commits $200 Million to Urban Real Estate

The New York Common Retirement Fund has committed $200 million to a fund that invests in real estate in New York City, Los Angeles and other urban areas.

Researcher: High Transition Costs For States Switching From DB to DC Plans Are a “Myth”

Anthony Randazzo, director of economic research for the Reason Foundation, recently sat down with CapCon to talk about the concept of a state switching from a defined-benefit system to a defined-contribution system.

Disclosure: the Reason Foundation is a libertarian-leaning research organization.

Randazzo has published research in the past claiming that the “transition costs” of switching from a DB to a DC plan are largely a myth – and he expanded on that view in the interview.

From Michigan Capitol Confidential:

Michigan Capitol Confidential: You argue that these “transition costs” are a myth. What’s the basis for that myth?

Randazzo: The myth is based on two mistaken assumptions that certain steps need to be taken when switching from a defined-benefit system to a defined-contribution system. They are:

(1) That government must start making bigger debt payments to the defined-benefit system after it is closed.

(2) That a defined-benefit system needs new members in order to keep it solvent.

Neither of these assumptions are true. Regarding the first mistaken assumption; it might be recommended that a government increase the size of its debt payments after the system has been closed in order to pay off the debt sooner, but there is no legal requirement that it do so.

Regarding the second mistaken assumption, defined-benefit systems are supposed to be fully funded on a yearly basis by employer and employee contributions plus investment earnings. These systems are not based on new workers subsidizing older workers.

Michigan Capitol Confidential: So we have this disagreement between independent pension experts and individuals with an interest in the current systems. What’s at the core of this disagreement?

Randazzo: I think it is a disagreement between philosophies. It’s true that a defined-benefit system could be changed to a defined-contribution system that would be more expensive. But to prevent this, all you would have to do is put in a defined-contribution rate that ensures lower costs. Therefore, if the defined-contribution system – that’s put in place to try to solve a growing debt problem being created by a defined-benefit system – ends up costing too much, to me, that’s not a transition cost, it’s just the result of a bad policy decision.

[…]

Michigan Capitol Confidential: And you would argue that switching to a defined-contribution pension system would do away with most of the guesswork.

Randazzo: A defined-contribution system is 100 percent more transparent than a defined-benefit system because it requires zero actuarial assumptions about the future, and zero backroom negotiations with pension boards and union members. The costs of a defined-contribution system are clear every year: it is simply whatever the government body has chosen to be the contribution rate to each employee’s retirement account. The cost is known each year, and taxpayers don’t have to worry about whether investment returns will equal assumptions, or whether people will wind up living longer than expected and costing the system more money than it has projected pensions to cost.

Read the full interview here.

Photo by 401kcalculator.org

Quebec Passes Controversial Pension Reform Into Law

Despite the legal threats of unions and the protests of public workers, Quebec’s controversial pension reform measure passed into law Thursday.

The law, Bill 3, mandate that workers contribute a higher percentage of their paychecks to their pensions. In short, they split the bill 50-50 with municipalities.

More details from CBC:

The bill was passed on Thursday morning at the National Assembly by a vote of 85-28.

The law will force municipal workers and retirees to contribute more to their pensions to offset a $4-billion pension fund deficit.

[…]

Liberal Premier Philippe Couillard defended the reforms during question period in the National Assembly.

“In Quebec, we don’t spend more than what we have,” he said.

“The reality of catching up — there are millions of dollars to get back. We’re doing it with courage, we’re doing what was supposed to be done before. And why are we doing it? We’re doing it for today’s Quebecers and the next generations to whom we want to pass on a Quebec in good financial health,” Couillard said.

Members of the opposition parties groaned when Couillard said the move was to overcome a $5.8-billion deficit.

[…]

Municipal Affairs Minister Pierre Moreau’s reforms passed with just two amendments to the bill.

One was to take some of the burden off retirees when it comes to paying off the deficit.

The second gives municipal workers’ unions and the province more flexibility in contract negotiations.

Bill 3 can be read here.

Illinois Passes Bill To Automatically Enroll 2.5 Million Workers in Retirement Plans

Illinois lawmakers have passed a bill that would allow 2.5 million private-sector employees without retirement plans to enroll in a Roth IRA. Both the House and the Senate passed the bill on Wednesday, and Quinn is expected to sign the measure.

Crain’s explains how the program, called Secure Choice, would work:

[The program] would apply to employees of firms with at least 25 workers who do not have access to an employer-provided retirement account.

[…]

Under the measure, qualifying employees will be asked now or when they are hired whether they want to contribute 3 percent of their salary to a retirement account. Unless they say no, the money will be deducted from their check, just like taxes, and go into an individual Roth Individual Retirement Account that will be tax-free after retirement.

Operating much like the state’s Bright Start college savings program, a panel including the state treasurer, budget chief and several outside directors named by the governor will hire a private firm that will run the program and offer various investment options. The program, called Secure Choice, will be portable, carrying over to a new employer if a worker changes jobs. Employees can contribute more or less than 3 percent of their salary if they choose.

AARP “applauded” the passage of the bill. The group said in a press release:

“Today, the General Assembly took a monumental step toward helping to ensure a more secure financial future for small business employees in Illinois by passing Senate Bill 2758 – the Illinois Secure Choice Savings Program.”

[…]

“The Illinois Secure Choice Savings Program means more private savings, a stronger competitive edge for small businesses, and a more secure financial future for our state. Over 2 million Illinois workers who did not previously have access to a workplace retirement plan will now have access to an Individual Retirement Account – and many small businesses in Illinois will, for the first time, be able to offer current and potential employees the benefit of a workplace retirement account.”

Some lawmakers vocally opposed the program on the grounds that it was rushed through the legislature and not enough time was put into investigating the consequences for small businesses. From Illinois Watchdog:

Representative Ron Sandack said the issue should have more investigation before another mandate is levied against small business.

“Yes, people aren’t saving up for retirement, yes we ought to do more to incentivize that,” he said. “No, we shouldn’t mandate a program that we don’t know a thing about. We shouldn’t mandate small business and encumber small business, yet again, with an expense and a burden that we really don’t know anything about.

The language of the bill – called S.B. 2758 – can be read here.

Photo credit: “Gfp-illinois-springfield-capitol-and-sky” by Yinan Chen – www.goodfreephotos.com (gallery, image). Via Wikimedia Commons

Biggs: Public Pensions Take On Too Much Risk

Andrew Biggs, former deputy commissioner of the Social Security Administration and current Resident Scholar at the American Enterprise Institute, penned a column for the Wall Street Journal this week in which he posed the thesis that public pension funds invest in too many risky assets.

To start, he compares the asset allocations of an individual versus that of CalPERS. From the column:

Many individuals follow a rough “100 minus your age” rule to determine how much risk to take with their retirement savings. A 25-year-old might put 75% of his savings in stocks or other risky assets, the remaining 25% in bonds and other safer investments. A 45-year-old would hold 55% in stocks, and a 65-year-old 35%. Individuals take this risk knowing that the end balance of their IRA or 401(k) account will vary with market returns.

Now consider the California Public Employees’ Retirement System (Calpers), the largest U.S. public plan and a trendsetter for others. The typical participant is around age 62, so a “100 minus age” rule would recommend that Calpers hold about 38% risky assets. In reality, Calpers holds about 75% of its portfolio in stocks and other risky assets, such as real estate, private equity and, until recently, hedge funds, despite offering benefits that, unlike IRAs or 401(k)s, it guarantees against market risk. Most other states are little different: Illinois holds 75% in risky assets; the Texas teachers’ plan holds 81%; the New York state and local plan 72%; Pennsylvania 82%; New Mexico 85%.

The column goes on:

Managers of government pension plans counter that they have longer investment horizons and can take greater risks. But most financial economists believe that the risks of stock investments grow, not shrink, with time. Moreover, while governments may exist forever, pensions cannot take forever to pay off their losses: New accounting rules promulgated by the Governmental Accounting Standards Board (GASB) and taking effect this year will push plans to amortize unfunded liabilities over roughly 15 years. Even without these rules, volatile pension investments translate into volatile contribution requirements that can and have destabilized government budgets.

Yet public-plan managers may see little option other than to double down on risk. In 2013 nearly half of state and local plan sponsors failed to make their full pension contribution. Moving from the 7.5% return currently assumed by Calpers to the roughly 5% yield on a 38%-62% stock-bond portfolio would increase annual contributions by around 50%—an additional $4 billion—making funding even more challenging.

But the fundamental misunderstanding afflicting practically the entire public-pension community is that taking more investment risk does not make a plan less expensive. It merely makes it less expensive today, by reducing contributions on the assumption that high investment returns will make up the difference. Risky investments shift the costs onto future generations who must make up for shortfalls if investments don’t pay off as assumed.

Read the entire column here.

Photo by dktrpepr via Flickr CC License

San Francisco Pension To Consider Smaller Foray Into Hedge Funds

The San Francisco Employees’ Retirement System has spent the better part of 6 months weighing whether to dive into hedge funds for the first time.

The fund was originally considering a plan to invest up to 15 percent of assets – or $3 billion – in hedge funds. But the figure was too high for many board members, and the vote was tabled numerous times.

Now, the board is considering a proposal that would allow the fund to invest up to 3 percent of assets in hedge funds – a much smaller allocation that may be more palatable to board members.

From Bloomberg:

The president of the San Francisco Employees’ Retirement System board has asked advisers to look at a hedge fund investment of zero or 3 percent, less than the 15 percent proposed by the pension’s staff.

The board will meet today in San Francisco to consider the proposals, which are part of a broader effort to recalibrate the fund’s asset allocation. The updated figures were in a letter from Angeles Investment Advisors.

“The VM mixes have higher volatility,” Leslie Kautz and Allen Yeh wrote in a Nov. 25 memo to Victor Makras providing modeling on several mixes that they said he specified.

[…]

The hedge fund proposal stems from a June meeting when the San Francisco staff recommended changes to the fund’s asset allocation and the board voted to take 90 days to study options.

The staff recommended a 15 percent hedge-fund allocation, citing good returns, low volatility and very good risk-adjusted returns, according to a memo today to the board from William Coaker, the fund’s chief investment officer.

“Hedge funds provide good protection when stocks decline,” Coaker said. “Since 1990, they have lost only one-fourth the amount stocks have lost in market downturns.”

The San Francisco Employees’ Retirement System manages $20 billion in assets, none of which are allocated to hedge funds.

Photo by ilirjan rrumbullaku via Flickr CC License

Ontario Teachers’ Pension Chief Explains Why Fund Looks Outside of Canada For Direct Investment Opportunities

The Ontario Teachers’ Pension Plan (OTPP) is among the growing number of pension funds making large direct investments in companies – buying stakes in companies directly as opposed to working with private equity firms.

But the vast majority of the OTPP’s direct investments are made in foreign companies, not Canada. Why is that?

OTPP chief executive Ron Mock explained on Wednesday the methodology that leads the fund to leave Canada behind when making direct investments. From the Financial Post:

The Ontario Teachers’ Pension Plan may prefer to make its direct investments outside of Canada, but don’t interpret that as a sign the institution isn’t confident in the country’s economy, chief executive Ron Mock said on Wednesday.

Mr. Mock made the remarks at The Canada Summit 2014, a conference hosted by The Economist magazine in Toronto. Mr. Mock discussed the biggest opportunities and challenges facing the pension fund.

In the early 2000s, the teachers’ pension plan shifted away from a traditional mix of bonds and equities into direct, private investments, a move Canada’s other major pension plans followed. Mr. Mock, who has been on the job for about a year, said the shift in strategy was necessary to generate the returns it needed to provide retirement income for 300,000 working and retired teachers.

Today, about 70% of the pension fund’s direct, private investments are outside Canada, Mr. Mock said.

[…]

The strategy has come with challenges. Mr. Mock said one of the biggest difficulties is navigating the legal systems and governance requirements of foreign countries when buying large stakes in their companies.

Mr. Mock cited Asian companies that have not yet gone public among investment opportunities he’s keeping an eye on. He said the pension fund doesn’t typically make venture capital investments in Canadian companies because those types of investments are generally in the tens of thousands of dollars, while he’s looking to invest hundreds of millions at a time.

“As a fiduciary, we really do have to focus on earning the returns on behalf of the teachers,” he said.

Another opportunity he’s keeping his eye on is infrastructure investments in Europe and Canada. He said pension funds have a role to play in helping Canada address its crumbling infrastructure problem over the next 10 years.

“I think that is a vital opportunity in Canada,” he said.

The OTPP manages $140 billion in assets.

Moody’s: New Jersey Pensions Could Run Dry In 10 Years

In a new report from Moody’s, the ratings agency warns that two of New Jersey’s largest state-level pension systems – the New Jersey Public Employees Retirement System (PERS) and the Teachers’ Pension and Annuity Fund (TPAF) – could dry up in the next decade.

Reported by the Associated Press:

The finding by Moody’s comes after the state’s recent announcement that public pension liabilities nearly doubled to $83 million, due to new accounting rules.

The agency laid out its concerns in a report this week. Among the concerns it raises are the possible depletion of public worker and teacher pension funds by 2024 and 2027, respectively.

Despite the concerns, Moody’s said the new liability figure is in line with its own calculations. Moody’s has downgraded the state’s credit rating twice, in part due to the pension fund.

Gov. Chris Christie cut the state’s contribution to pensions earlier this year amid budget hardships by nearly $1 billion, lowering it to almost $700 million.

New Jersey recently began implementing new GASB accounting rules. The rules change the way the state calculates pension liabilities, which is why the funding ratio of the state’s pension systems dropped 20 points last week.

But the change was expected, and was already figured into Moody’s analysis of the state’s pension funding situation.

Photo by B Smith via Flickr CC License

Exploring the Relationship Between Pension Funds and Private Equity Firms

Finance blog Naked Capitalism has published a long interview with Eileen Appelbaum and Rosemary Batt, authors of Private Equity at Work, a book that dives into the inner-workings of the PE industry.

Part of the Naked Capitalism interview, conducted by Andrew Dittmer, covers the relationship between limited partners (pension funds) and general partners (PE firms). Here’s that portion of the interview:

Andrew Dittmer: In general, LPs seem to have a pretty submissive attitude toward GPs. Where do you think this attitude comes from?

Rosemary Batt: One cause is the difference in information and power. Many pension funds don’t have the resources to hire managers who are sophisticated in their knowledge of private equity firms. They don’t have the resources to do due diligence to the extent they would like to, so they need to rely on the PE fund, essentially deferring to them in what they say.

Eileen Appelbaum: I think that there is a reluctance to question this information or to share it with other knowledgeable people – they are afraid that if they do, they will not be allowed to invest in the fund because the general partners will turn them away.

I attended a lunchtime lecture recently, the title of which was “How is it that private equity is the only industry in which 70% of the firms are top-quartile?”The general partners have found ways to persuade their investors that they are the top-quartile funds, that “you will make out best if you invest with us,”and “we’re very particular – if you can’t protect our secret sauce, we aren’t going to do business with you.”

The other side of it is that some of the pension funds have their own in-house experts, and some of them believe they’re smarter than the average bear – there’s a certain pride in their ability to get the best possible deal, better than other LPs can get.

It’s the lack of transparency. With more transparency we’d have a lot less of these problems.

Rosemary Batt: Another issue is yield – often they’re thinking, “We need to be investing in private equity or alternative investment funds because this is the only way to get higher yields.” There’s a kind of halo effect, if you will, around the private equity model – many people think it really does produce higher returns without really having the knowledge. In some cases, there are political battles that have to be fought to get legislators to make a decision not to invest in these funds.

Eileen Appelbaum: Often the person who is appointed to make the decisions about private equity investments comes from Wall Street, maybe even from a PE background.

[…]

Eileen Appelbaum: Rose and I did a briefing at the AFL for the investment group. We had investment people from both union confederations who are concerned about the fact pension funds are putting so much money into private equity. They told us that they had never been able to see a limited partner agreement until Yves Smith published them. The pension fund people are so afraid of losing the opportunity to invest in PE. Some general partner could cut them off for having shared the limited partner agreement. Unbelievable.

This is the only section of the interview that deals explicitly with pension funds, but the whole interview is worth reading. You can read it here.

Pension Advisory Board: Divesting From Fossil Fuels Will Harm Future Returns

There have been calls from many corners in recent months and years for pension funds and other institutional investors to begin divesting from fossil fuel-based investments.

But not many institutional investors have heeded that call, choosing instead to use their sway as major shareholders to work with companies.

One of the largest asset holders in the world is taking a similar approach. The board of the $857.1 billion Norway Pension Fund Global has told the fund that divesting from fossil fuels would be an unwise financial decision that would reduce returns.