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Public Pensions Experience First Negative Quarter Since Early 2013 As Investments Decline

The median return of public pension investments was –1 percent in the third quarter, according to a Wilshire Trust Universe Comparison Service report.

It was the first negative quarter in over a year for public plans, collectively.

More on third quarter performance, from Reuters:

Public pensions lost a median 1.00 percent in the third quarter, compared with a median drop of 0.84 percent for all plans over the same period. Wilshire’s benchmark investment performance measure is gleaned from nearly 1,600 plans, including corporate plans, foundations and endowments.

The biggest losers: small public pensions with less than $1 billion of assets. Their returns were down a median 1.07 percent for the quarter.

Larger corporate funds with more than $1 billion of assets had the best showing for the second quarter in a row, losing just 0.54 percent this past quarter.

Overall, the various plans suffered their first negative quarter since the second quarter of 2013, Wilshire said.

The funds’ underperformance was a surprise, said Robert Waid, managing director at Wilshire Associates, in a quarter when the Barclays U.S. Aggregate Index rose 0.17 percent.

“This is a quarter where classic diversification did not pay, with U.S. small-cap, international equity, real estate and commodities all underperforming,” Waid said in a statement. “This explains why the median performance for all plan types underperformed the classic 60/40 portfolio.”

In the second quarter, public pensions’ performance had improved greatly, returning a median 3.71 percent and outperforming peers, Wilshire data showed.

The Wilshire Trust Universe Comparison Service (TUCS) is a widely accepted benchmark for institutional investment performance, representing $3.7 trillion in institutional assets from over 1600 plans and endowments.

Video: Pension Limbo Spurs Early Retirement in Illinois

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The legality of Illinois’ pension reform law is up in the air, and may remain so until year’s end. That puts many soon-to-be-retirees in an unusual position: they can retire early and lock in their benefits, or they can wait to see the outcome of the state’s pension legal battle.

Many are choosing the former, according to ABC 20 .

Ontario Teachers’ Pension Becomes One of BlackBerry’s Top 10 Shareholders

The Ontario Teachers’ Pension Plan saw something it liked in BlackBerry in the third quarter, as the pension fund bought into the company to the tune of 7.8 million shares. Now, the fund is among the company’s ten largest shareholders.

Waiver on Retirement Income Tax Gains Steam in Rhode Island

Rhode Island is one of a handful of states that tax social security and pension benefits. But the idea of offering a waiver on those taxes is gaining momentum in the state, and the push for retiree tax relief is coming from several directions. The idea has been proposed by labor group leaders, who say a waiver could be part of a settlement in the lawsuit over the state’s 2011 pension reforms. From the Providence Journal:

The president of the Rhode Island retiree chapter of the American Federation of Teachers is “cautiously optimistic” that a waiver of state taxes on pensions and Social Security benefits could provide the framework for a settlement of the high-stakes pension lawsuit. […] Roger P. Boudreau, the state retirement board member who is also president of the Rhode Island branch of the AFT’s retirees chapter, made this prediction on October 28, at an informational meeting of members of the Rhode Island Public Employees’ Retiree Coalition. The coalition was created to represent retirees’ interests in the union challenge to the state’s 2011 pension overhaul. Boudreau could not be reached for comment on Friday. But his Oct. 28 comments were captured in the “RIPERC Legal Defense Fund Newsletter” for October-November 2014 that said, in part: “Roger also expressed cautious optimism that an opportunity to settle the dispute through negotiations with the General Assembly would occur in the upcoming session. One of the things that Roger spoke about exploring is a waiver of RI income taxes for pensions and Social Security; a statutory waiver would have a major impact on retirement security for all retirees, and the labor movement has always represented all workers, including nonmembers, in a quest for economic and social justice.” […] Added Robert Walsh, the executive director of the National Education Association of Rhode Island: ”The idea has been around for years – probably before Gina was Treasurer [and] dating back to the first pension lawsuit. “I think it makes sense either on a stand-alone basis or as part of a larger settlement but no discussions are ongoing that I am aware of, but the retiree group has its own steering committee and lawyer,” Walsh said. “On the bigger issue, I support the resumption of settlement discussions and if there are ideas such as income tax relief on pensions and Social Security that will help resolve the issue they should be fully explored,” Walsh said. “Until the lawsuits are resolved it will be hard to focus on other issues, so a comprehensive settlement would be good for all concerned.”

Unions aren’t the only ones championing the waiver on retirement income. State lawmakers are looking for ways to make Rhode Island friendlier to retirees, although they remain non-committal on specific proposals. According to the Providence Journal:

House and Senate leaders just this week cited tax relief for retirees as one of their top priorities for the new legislative session that will begin in January. […] This was the response from House Speaker Nicholas Mattiello’s spokesman on Friday, when asked if Mattiello had [a waiver] in mind when he pledged on Thursday to seriously consider the exemption of state taxes on pension and other retirement income: “He said the intent of the legislation he is looking closely to enact is to help all retirees and has nothing to do with the pension lawsuit. He said any consideration of the pension lawsuit would be dealt with independently.” When asked Friday where she stood on a state tax exemption for retirement income, Governor-elect Gina Raimondo said she would need to see specifics before she could evaluate the proposal.

In Rhode Island, out-of-state government pensions are fully taxed as income. Photo by John Morgan via Flickr CC License

Lowenstein: Do Pension Fund Make Investing Too Complex?

Former New York Times financial writer Roger Lowenstein wonders in his new Fortune column whether pension investments have become too complex.

Lowenstein’s thesis:

Pricey consultants have convinced many pension funds to pile into private equity, real estate and hedge funds, which don’t necessarily promise higher returns or long-term investing.

[…]

[Pension funds] have assembled portfolios that are way too complex, way too dependent on supposedly sophisticated (and high fee) investment vehicles. They have chased what is fashionable, they have overly diversified, and they have abandoned what should be their true calling: patient long-term investing in American corporations.

[…]

It’s true that the stock market doesn’t always go up. But a long-term investor shouldn’t be wary of volatility. Over the long term, American stocks do go up. And state pension systems should be the ultimate long-term investors; their horizon is effectively forever.

Lower volatility helps fund managers; they don’t like having to explain what happened in a bad year. But it is not good for their constituents. The Iowa system has trailed the Wilshire stock index over 10 years—also over five years, three years, and one year. Over time, that translates to higher expenses for employees or for Iowa taxpayers. And Iowa is typical of public funds generally.

[…]

Many hedge funds trumpet their ability to dampen volatility. Pension funds should not be in them. From 2009 to 2013, a weighted index of hedge funds earned 8% a year, according to Mark Williams of Boston University. The return on the S&P 500 was more than twice as much, and a blended 60/40 S&P and bond fund earned 14%. Granted, a small minority of hedge funds consistently beat the index. But most public pensions will not be in such superlative funds.

Lowenstein on private equity:

Private equity remains the rage. However, private equity is hugely problematic. Those confidential fees are often excessive—with firms exacting multiple layers of fees on the same investment.

Moreover, there is no reliable gauge of returns. Private equity firms report “internal rates of return.” These do not take into account money that investors commit and yet is not invested. “The returns are misleading,” says Frederick Rowe, vice chairman of the Employee Retirement System of Texas. “The professionals I talk to consider the use of IRRs deceptive. What they want to know is, ‘How much did I commit and how much did I get back?’”

Since no public market for private equity stakes exists, annual performance is simply an estimate. Not surprisingly, estimates are not as volatile as stock market prices. But the underlying assets are equivalent. A cable system or a supermarket chain does not become more volatile by virtue of its form of ownership.

The fact that reported private equity results are less volatile pleases fund managers. But the juice in private equity comes from its enormous leverage. Pension managers would be more honest if they simply borrowed money and bet on the S&P—and they would avoid the fees. And if high leverage is inappropriate for a public fund, it is no less inappropriate just because KKR is doing it.

Lowenstein ends the column with a call for pension funds to renew their focus on “long-term goals”:

With their close ties to Wall Street, pension managers tend to be steeped in the arcane culture of the market. The web site for the Teacher Retirement System of Texas refers to its “headlight system” of “portfolio alerts” and the outlook for the U.S. Federal Reserve and China.

Managers who think in such episodic terms tend to be traders, not investors. This subverts the long-term goals of retirees.

The focus on the short and medium term squanders what a pension fund’s true advantage is. You may not have thought that public funds had an advantage, but they wield more than $3 trillion and have the freedom to invest for the very long term.

Better than chase the latest “alternative,” pensions could become meaningful stewards of corporate governance—active monitors of America’s public companies. A few fund managers, including Scott Stringer, the New York City comptroller, who oversees five big funds, are moving in this direction, seeking board roles for their funds. More should do so, but that will require an ongoing commitment. It will require, in other words, that pension funds stop acting like turnstile traders and fad followers, and that they start behaving like investors.

Read the entire column here.

Photo by Victoria Pickering via Flickr CC License

Why Have Local Governments Been Slow to Adopt Automatic Enrollment Practices?

As defined-benefit plans around the country become more costly, some local governments have begun switching new hires into defined-contribution (DC) plans.

But those same governments have been slow to adopt automatic enrollment practices, according to a report published in the November issue of Pension Benefits.

From the article:

The public sector has been much slower that the private sector to adopt automatic enrollment for its defined contribution (DC) plans: only 2% use automatic enrollment. Currently, five states have automatic enrollment for the DC plans available for their workers: Georgia (ERSG), Missouri (MOSERS), South Dakota (SDRS), Texas (TRS), and Virginia (VRS).

[…]

Workforce trends and the current state of public retirement benefits strongly suggest that DC features that encourage savings, such as automatic enrollment, can play an important role in the retirement income security of many public employees.

So why haven’t local governments adopted auto enrollment practices? The article’s author, Paula Sanford, offers some reasons:

– Legal constraints. Only 11 states permit automatic enrollment for public DC plans. In a few places, an exemption to anti-garnishment laws has been written into statute for a particular retirement system or plan.

– Perception. Government leaders worry that automatic enrollment in a supplemental savings plan might overburden their employees, especially those who earn modest wages.

– Labor questions. There is debate in the labor community about whether automatic enrollment should be supported.

– Administrative challenges, such as multiple record keepers.

Cobb Country, Georgia, offers an example of how auto enrollment can increase participation:

The county started automatic enrollment for new employees in January 2013, and the feature has been very successful at increasing participation in the 457(b) plan. Prior to automatic enrollment, countywide participation in the 457(b) plan was only at about 33%; yet in just a little over a year, it has increased to 57.5%. This increase is striking considering that approximately two-thirds of the employees still participate in the original DB plan. The initial employee contribution under automatic enrollment is 1% of salary, and the county has kept its matching formula for all hybrid plan participants.

Read the full report, containing further analysis and other examples, in the latest issue of Pension Benefits or here.

Photo by TaxCredits.net

CalSTRS Appoints Three Key Investment Staff As Fund Completes Restructuring

CalSTRS has finished a restructuring of its investment staff, and announced Friday it had made three key appointments: the fund hired its first Chief Operating Investment Officer, as well as new directors of Fixed Income and Inflation Sensitive investments.

From a CalSTRS release:

Debra Smith has been selected CalSTRS Chief Operating Investment Officer (COIO). Glenn Hosokawa was named director of the $22.4 billion asset class, Fixed Income, the funds’ second largest. Paul Shantic was named Director of Inflation Sensitive, the newest and smallest asset class with an investment portfolio at $1.4 billion.

“These three appointments, coupled with our 2010 creation of a Deputy Chief Investment Officer, completes a new organizational structure that allows us to bring more assets in-house,” said CalSTRS Chief Investment Officer Christopher J. Ailman. “This structure matches what you find in most large investment money managers. This also fits our plans to internally manage more of our assets–currently at 45 percent in-house–to a projected 60 percent internally managed.”

[…]

All three moved up from high-level positions in CalSTRS. Ms. Smith was director of investment operations. Messrs. Hosokawa and Shantic were acting co-directors of Fixed Income. All three come with deep knowledge and experience in finance and investment management and operations.

CalSTRS’ inaugural COIO, Ms. Smith, has risen through the ranks at CalSTRS from associate investment officer in 1998 to director of investment operations in 2010. She holds a Bachelor of Science degree from Fresno State University in business administration, finance and marketing. In 2012 she received a certificate as a graduate of the CalSTRS Management Academy. Ms. Smith is currently enrolled in the CalSTRS Executive Development Program with a graduation date of November 2014.

“I look forward to collaborating with investment management at CalSTRS and with our strategic business partners to put in place adaptive and innovative solutions to achieve our mission, which is securing the financial future and sustaining the trust of California’s educators,” Ms. Smith said.

More on the fund’s new investment staff structure:

The new structure has the COIO overseeing Investment Operations, Branch Administration, and a new unit comprised of Compliance, Internal Controls, Ethics and Business Continuity. The new position will also directly report to the Investment Committee twice per year. This fulfills a goal of CalSTRS’ internal auditors, who recommended the separation between investment management and investment operations.

“This new structure puts in place a smoother operation for a portfolio of our size and allows for better oversight by the board, the Deputy CIO and myself,” said Mr. Ailman, adding that: “The competition for these positions was very intense and was nationwide in scope, which speaks well for the quality of the talent we have in house.”

Read the entire release, including bios of the three appointees, here.

Fitch: Hedge Funds Will Continue “Winning and Keeping” Public Pensions Assets

Fitch Ratings predicts that, despite several high-profile exits by pension funds this year, hedge funds will continue to count public pension funds as major investors.

The ratings agency says exits by funds like CalPERS are “not representative of broader sector trends” and says it believes hedge funds still “deliver competitive returns net of fees, while providing a degree of downside protection and uncorrelated return during periods of stress”.

From Fitch:

Recent decisions by two large US public pension plans to pull back from hedge fund investments, and the likelihood of a sixth consecutive calendar year of return averages underperforming broad equity market returns, are not expected to curb investors’ overall allocations to hedge funds, according to Fitch Ratings.

Barring an unforeseen major market decline, hedge fund assets under management (AUM) should continue on a path toward $3.0 trillion, good growth relative to 2013’s year-end level of $2.6 trillion. The rise is attributable to market appreciation and inflows outpacing redemptions. The AUM flows show significant variation by strategy, with equity-oriented funds attracting more capital in recent periods, but global macro funds falling from favor.

While hedge fund growth has certainly slowed over the past several years, the high-profile pension plan withdrawals seen over the past six weeks are not representative of broader sector trends, in our view.

The Fitch report backs its conclusions with data from several studies conducted this year:

Fitch points to analysis recently compiled by Preqin as an indicator of the progress that hedge funds have made in winning and keeping US public pension assets more broadly. The data generally shows improvements in hedge fund investment allocations by public pensions since 2010. As of June 2014, 269 public pensions in the US made allocations to hedge funds, with an average of about 8.6% of their total AUM allocated to hedge funds.

[…]

Over the past decade and a half, hedge funds have delivered steadier performance relative to the overall market during bear markets, as was seen in 2000 to 2002 and in 2008. This downside protection, however, comes at the expense of limited upside during bull markets, a trend seen in 2003, 2009 and especially 2013.

According to Hedge Fund Research, hedge fund performance averages are set to be nearer to the broad equity market measures in 2014. However, trailing 36- and 48-month annual return levels generally range around low single-digit percentages, which paint the entire sector as under delivering relative to broader equity index benchmarks.

Read the full Fitch release here.

Placement Agent in CalPERS Bribery Case Pleads Not Guilty

Alfred Villalobos, the former CalPERS board member and placement agent who allegedly bribed then-CalPERS Chief Executive Fred Buenrostro to the tune of $250,000, pleaded not guilty to bribery charges on Wednesday.

Buenrostro has already pled guilty to charges that he accepted the $250,000 bribe and falsified pension fund documents with Villalobos.

San Francisco Pension Not Expected to Approve Hedge Fund Proposal, But Alternate Plan Could Pass

Trustees of the San Francisco Employees’ Retirement System will vote sometime in the next few weeks on a proposal to invest up to 15 percent of assets – or $3 billion – in hedge funds.

The vote has been proposed and tabled nearly half a dozen times since May.

According to reporting by Pensions & Investments, the proposal isn’t expected to pass a vote – although a toned-down version, where hedge fund investments are capped at 5 percent of assets, has a better chance at passing.

From Pensions & Investments:

The board of the San Francisco City & County Employees’ Retirement System is expected to reject Chief Investment Officer William Coaker’s plan for a 15% allocation to hedge funds at a meeting in the next several weeks and instead limit hedge funds to no more than 5% of the portfolio, sources say.

The board had been scheduled to vote on the hedge fund allocation at a special meeting scheduled for Wednesday.

Board President Victor Makras said in an interview that a new special meeting will be held in the next few weeks. He said he will schedule the meeting as soon as he can poll members for a suitable date.

He said the Nov. 5 meeting was canceled because several board members were traveling out of the country.

The board is also expected, as part of the hedge fund vote, to bar or severely limit the use of leverage by hedge fund managers, a common tactic used by such mangers to increase returns.

Mr. Coaker’s plan would shift assets from fixed income and equities to create the new hedge fund allocation.

If the “15 percent” plan passes, the following allocation changes would occur elsewhere in the fund’s portfolio, according to SFGate:

U.S. and foreign stocks would drop to 35 percent from 47 percent of assets. Bonds and other fixed-income would fall to 15 percent from 25 percent. Real estate would rise to 17 percent from 12 percent. Private equity would rise to 18 percent from 16 percent. And hedge funds would go to 15 percent from zero.

The San Francisco Employees’ Retirement System currently does not invest in hedge funds. It manages $20 billion in assets.

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