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Video: A Closer Look At Phoenix’s Proposition 487

Proposition 487 is a Phoenix ballot measure that would close off the city’s defined-benefit pension plan for new hires and instead shift them into a 401(k)-style system. The measure would also prohibit pension “spiking” practices.

Prop. 487 has been surrounded by debate about its true cost, and whether it would reduce death and disability benefits for public safety workers — even though the measure is not intended to change public safety benefits.

The video [above] tackles these issues, and others, in an analysis of the measure.

The Role of Merit in the Career of a Mutual Fund Manager

Mutual fund managers hold in their hands the retirement income of millions of people. So it should be of great interest to retirees, and those approaching retirement, whether mutual fund managers are qualified for the job.

A recent study examined 2,846 managers of actively managed mutual to try and answer the question: what is the role of merit in the careers of mutual fund managers?

From the study, which was published in the Financial Analysts Journal:

The results provide evidence of the role of merit in the careers of managers of actively managed funds. Consistent with prior studies, we found that relative performance is an important determinant of career success as a mutual fund manager. We showed that managers who underperform on a style-adjusted basis are at greater risk of losing their jobs.

However, the evidence on the role of superior performance is less strong. Surviving managers of all tenures, even those who lasted 10 or more years, outperformed those with shorter tenures, but we also showed that they did not consistently outperform the market on a risk-adjusted basis or their style benchmark. Data on style-adjusted monthly returns show that solo managers with 10 or more years of tenure outperformed about as often as they underperformed.

When performance is calculated using Carhart or Jensen alphas, even solo managers with tenure of more than 10 years show no ability to beat the market on a risk-adjusted basis. The key to a long career in the mutual fund industry seems to be related more to avoiding underperformance than to achieving superior performance.

The study suggests that, for mutual fund managers, long careers don’t come as a result of consistently outperforming markets, but rather as a result of avoiding under-performance. From the study:

The lack of significantly better performance over time by long-tenure managers suggests that longevity is related to the avoidance of underperformance. Additional factors may be at work in impairing the performance of these managers. For example, researchers have found evidence that some underperforming managers at smaller funds are able to retain their positions despite their performance.

Additionally, other research has shown that a significant proportion of the best mutual fund managers earned their reputations with high rates of return early in their careers and had performance that was significantly worse later on. Whether this early performance was due to luck or early superior skills that atrophied later is subject to conjecture and further research.

The study, authored by Gary E. Porter and Jack W. Trifts, was published in the July/August issue of the Financial Analysts Journal. The entire paper and analysis can be read here.

Photo by www.SeniorLiving.Org

CalPERS Cautious on Real Estate Despite Owning Hot Property

For CalPERS, the empty lot that currently sits at Third and Capitol in downtown Sacramento represents both a past failure and future opportunity.

CalPERS owns the lot, which has sat vacant since the fund lost $60 million on a failed condo development there in 2007.

That’s why CalPERS is being cautious with plans to develop the lot, even if it’s a hot property with the new Sacramento Kings arena being built just a few blocks away.

From the Sacramento Bee:

CalPERS has become more conservative about developing property from the ground up and now says it will take its time before proceeding at the downtown site.

“We plan to be very smart before jumping back into construction,” said Ted Eliopoulos, the newly installed chief investment officer at the California Public Employees’ Retirement System.

That’s not to say the nation’s largest public pension fund is ignoring the site’s potential. With the Kings’ arena set for an October 2016 opening and the downtown market in a state of revival, Eliopoulos said CalPERS and its development partner, CIM Group of Los Angeles, are committed to eventually doing something big at Third and Capitol.

“It deserves a project of scale, an iconic project,” said Eliopoulos, the man who pulled the plug on the original condo and hotel towers in 2007 after construction had begun.

In the most extensive comments the pension fund has made about the site in years, Eliopoulos said CalPERS and CIM are trying to determine “what mix of office, apartment, retail would be most appropriate for the site, from an economic standpoint, from a community standpoint.”

More details on the failed condo development that was originally supposed to occupy the space:

For the past seven years…Third and Capitol has been a humbling reminder, for both CalPERS and the city, of the collapse of the real estate market.

With CalPERS as his major financial backer, Sacramento developer John Saca was going to build twin 53-story condo and hotel towers on the site that once housed the old Sacramento Union newspaper. Along with the Aura condo project proposed a few blocks east, the Saca Towers were going to launch a downtown housing boom.

Neither project materialized, but the Saca project was the more spectacular failure. The fenced-off site, now a ghost town of weeds, trees and concrete pilings, has become known in some quarters as “the hole in the ground.”

Billed as the tallest residential project on the West Coast, the towers got off to a surprisingly strong start.

[…]

Eventually, though, the project ran into big problems – namely, $70 million worth of cost overruns caused by troubles with the concrete pilings. After spending $25 million, CalPERS cut off funding in January 2007. The decision was made by Eliopoulos, a private developer who had just joined CalPERS as senior investment officer for real estate.

“That was my first week on the job,” Eliopoulos said. “That was the first decision that I made, to stop the project.”

Months of public wrangling ensued between the two partners, with Saca complaining that he’d been undermined by CalPERS. Eventually, the pension fund got control of the site, but at a cost. On top of the original $25 million, it spent an additional $35 million to satisfy contractors’ liens, repay a mortgage and perform some additional pre-construction work. (The customers’ deposits, parked in an escrow account, were also returned.) CIM Group, which has built several downtown Sacramento buildings and partnered with CalPERS on the Plaza Lofts project on J Street years ago, was brought in to manage the forlorn site and advise the pension fund on possible uses.

CalPERS lost $10 billion on real estate investments between 2008 and 2010. In the years since, its real estate portfolio has seen double-digit returns almost every year.

The fund plans to increase its real estate holdings by 27 percent by 2016.

Photo by Photo by Stephen Curtin

Detroit Pensioners Sue Actuarial Consulting Firm Over Allegedly Faulty Assumptions

Lawsuits are rolling in against Gabriel Roeder Smith & Company, an actuarial consulting firm enlisted by pension funds across the country for advice on return assumptions and other calculations.

The firm has worked with Detroit’s pension funds for decades. Now, pensioners from several of Detroit’s public pension systems are suing the firm for playing a part in bringing the systems to “financial ruin.”

From the New York Times:

Detroit has been a client of Gabriel Roeder since 1938, when the city first started offering pensions. Now the city is bankrupt, the pension fund is short, benefits are being cut and one of the system’s roughly 35,000 members, Coletta Estes, is suing the firm, contending it used faulty methods and assumptions that “doomed the plan to financial ruin.”

Gabriel Roeder’s job was to help Detroit’s pension trustees run a sound plan, she says, but instead the firm covered up a growing shortfall and encouraged the trustees to spend money they did not really have. Her complaint contends that the actuaries did this knowingly, “in concert with the plan trustees to further their self-interest.” The lawsuit seeks to have the pension plan made whole, in an amount to be determined at trial, and to have Gabriel Roeder enjoined “from perpetrating similar wrongs on others.”

Lawsuits like the one Ms. Estes filed have also been brought against Gabriel Roeder by members of Detroit’s pension fund for police and firefighters, and the fund for the employees of surrounding Wayne County.

[…]

Gabriel Roeder said the three lawsuits “are factually, legally and procedurally infirm and reflect a gross misunderstanding of the nature of actuarial services.”

In a written statement, the firm also said that it was still providing services to all three pension funds and would vigorously defend itself against the lawsuits “without further public comment.”

More details on the lawsuits, from the Times:

The three lawsuits are separate from Detroit’s bankruptcy case. They were filed in Wayne County Circuit Court by Gerard V. Mantese and John J. Conway, Michigan lawyers who have tangled with Detroit’s pension system before. The lawsuits focus on the calculations and analysis that Gabriel Roeder provided to the trustees. Like many city and state pension systems, those of Detroit and Wayne County are mature, complex institutions, governed by trustees who do not necessarily have sophisticated financial backgrounds and rely heavily on the meaningful advice and accurate calculations of their consultants.

Detroit’s trustees did not get that, Mr. Mantese and Mr. Conway contend. Even as the city slid faster and faster toward bankruptcy, its workers kept building up larger, costlier pensions, and the actuaries “assured the trustees that the plan was in good condition.”

“Gabriel Roeder recommended that the plan could maintain and increase benefits,” Ms. Estes contends in her complaint, which was filed in September. That might sound odd, coming from a plan member who stood to enjoy any increases. But Detroit was making promises it could not afford, and Ms. Estes is also a Detroit homeowner and taxpayer who argues she was harmed as the city kept piling more and more obligations onto its shrinking tax base.

As the residents of other struggling cities have discovered, public pension promises, once made, are extremely hard to break, even if the city goes bankrupt. Now Ms. Estes has lost not only part of her pension but much of the savings tied up in her house, while she and her neighbors overpay for paltry city services. She says she might have been spared some of the misery had Gabriel Roeder warned the trustees years ago that the pension system was unsustainable and recommended changes.

“We just got blindsided,” she said.

CalPERS Board Asks Private Equity Consultants: Are “Investors Having Their Pockets Picked” By Evergreen Fees?

http://youtu.be/gn7XSqZZanU

Over at Naked Capitalism, Yves Smith has posted an extensive analysis of the October 13^th meeting of CalPERS’ investment committee.

At the meeting, the committee heard presentations from three consultants: Albourne America, Meketa Investment Group, Pension Consulting Alliance.

The meeting gets interesting when one committee member asks the consultants about “evergreen fees”.

[The exchange begins at the 34:30 mark in the above video].

From Naked Capitalism:

The board is presented with three candidates screened by CalPERS staff. Two, Meketa Investment Group and Pension Consulting Alliance, are established CalPERS advisors. There’s one newbie candidate, Albourne America. Each contender makes a presentation and then the board gets a grand total of 20 minutes for questions and answers for each of them. This isn’t a format for getting serious.

To make a bad situation worse, most of the questions were at best softballs. For instance, Dana Hollinger asked what the consultants thought about the level of risk CalPERS was taking in private equity program. Priya Mathur asked if the advisors could do an adequate job evaluating foreign managers with no foreign offices. Michael Bilbrey asked how the consultants kept from overreacting to positive or negative market conditions.

One board member, however, did manage to put the consultants on the spot. The answers were revealing, and not in a good way. The question came from J.J. Jelincic, where he asks about a particular type of abusive fee, an evergreen fee.

Evergreen fees occur when the general partner makes its portfolio companies, who are in no position to say no, sign consulting agreements that require the companies to pay fees to the general partners. It’s bad enough that those consulting fees, which in industry parlance are called monitoring fees, seldom bear any resemblance to services actually rendered. Over the years, limited partners have wised up a bit and now require a big portion of those fees, typically 80%, to be rebated against the management fees charged by the general partners.

So where do these evergreen fees come in? Gretchen Morgenson flagged an example of this practice in a May article. The general partner makes the hapless portfolio company sign a consulting agreement, say for ten or twelve years. The company is sold out of the fund before that. But the fees continue to be paid to the general partner after the exit. Clearly, the purchase price, and hence the proceeds to the fund, will have been reduced by the amount of those ongoing fees, to the detriment of the fund’s investors. And with the company no longer in the fund, it is almost certain to be no longer subject to the fee rebates to the limited partners.

[…]

Jelincic describes the how the response said that the fees are shared only if the fund has not fully exited its investment in the portfolio company. Jelincic asks if that’s an example of an evergreen fee, and if so, what CalPERS should do about it.

Naked Capitalism on the consultants’ responses:

The response from Albourne is superficially the best, but substantively is actually the most troubling. The first consultant responds enthusiastically, stating that CalPERS is in position to stop this sort of practice by virtue of having a “big stick” as the SEC does. He says that other funds aren’t able to contest these practices.

The disturbing part is where he claims his firm was aware of these practices years ago by virtue of doing what they call back office audits. That sounds implausible, since the rights of the limited partners to examine books and records extends only to the fund itself not to the general partner or the portfolio companies (mind you, some smaller or newer funds might consent). But the flow of the fees and expenses that the limited partners don’t know about go directly from the portfolio company to the general partner and do not pass through the fund. How does Albourne have any right to see that?

But if they somehow really did have that information, the implication is even worse. It means they were complicit in the general partners’ abuses. If they really did know this sort of thing and remained silent, whose interest were they serving? It looks as if they violated their fiduciary duty to their clients.

The younger Albourne staffer claimed a lot of the fees were disclosed in footnotes and that most limited partners have been too thinly staffed or inattentive to catch them. That amounts to a defense of the general partners and if Albourne really did know about these fees, Albourne’s inaction.

However, The SEC doesn’t agree with that view and they have the right to do much deeper probes than Albourne does. From SEC exam chief Drew Bowden’s May speech:

[A]dvisers bill their funds separately for various back-office functions that have traditionally been included as a service provided in exchange for the management fee, including compliance, legal, and accounting — without proper disclosure that these costs are being shifted to investors.

For these fees to be properly disclosed, they had to have been set forth in the limited partnership agreement or the subscription docs for the limited partners, meaning before the investment was made, to have gotten proper notice. Go look at any of the dozen limited partnership agreements we have published. You don’t see footnotes, much the less other nitty gritty disclosure of exactly who pays for what. Not very clear disclosures after the limited partners are committed to the funds, to the extent some general partners provide them, do not constitute proper notice and consent.

Meketa was clearly not prepared to field Jelincic’s question and waffled. They effectively said they thought the fees were generally permissible but more transparency was needed. They threw it back on CalPERS to be more aggressive, particularly on customized accounts, and urged them work with other large limited partners.

Pension Consulting Alliance was a tad less deer-in-the-headlights than Meketa but in terms of substance, like Albourne, made some damning remarks. The consultant acted if evergreen fees might be offset, which simply suggests he is ignorant of the nature of this ruse. He said general partners are looking to do something about it, implying they were intending to get rid of them, but said compliance was inconsistent. Huh? If the funds intend to stop the practice, why is compliance an issue? This is simply incoherent, unless you recognize that what he is actually describing is unresolved wrangling, not any sort of agreement between limited and general partners that charge these fees on this matter. He also said he would recommend against being in funds that have evergreen fees. But there was no evidence he had planned to be inquisitive about them before the question was asked.

You’ll notice that all of the answers treat the only outcome as having CalPERS, perhaps in concert with other investors, be more bloody-minded about evergreen and other dubious fees. You’ll notice no one said, “Yes, you should tell the SEC this stinks. You were duped. You should encourage the SEC to fine general partners who engaged in this practice and encourage the SEC to have those fees disgorged. That would to put an end to this. Better yet, tell the general partners you’ll do that if they don’t stop charging those fees and make restitution to you. That’s the fastest way to put a stop to this and get the most for your beneficiaries.” Two of the three respondents said CalPERS is in a position to play hardball, so why not take that point of view to its logical conclusion?

But this is what passes for best-of-breed due diligence and supervision in public pension land. Imagine what goes on at, say, a municipal pension fund.

Read the entire Naked Capitalism post, which features more analysis, here.

After Deadlock, Los Angeles Pension Lowers Assumed Rate of Return

The board of the Los Angeles City Employees’ Retirement System (LACERS) has voted to lower its assumed rate of return from 7.75 percent to 7.5 percent – a move that was recommended by the fund’s financial consultants and supported by six of its seven board members.

From the Los Angeles Times:

Los Angeles city pension agency voted Tuesday to rein in its long-range earnings forecast, putting in place changes that could throw the city’s budget $50 million deeper into the hole next year.

The City Employees’ Retirement System board responded to financial consultants who said the agency should no longer assume that its investment portfolio — money that helps cover the cost of employee pensions — will deliver an average yearly return of 7.75%.

[…]

Pension board member Elizabeth Greenwood cast the only opposing vote, saying the city needs more time to emerge from its recent financial crisis. Greenwood had called for the change, which will reduce the system’s earnings assumption to 7.5%, to be delayed until 2017.

“There is no reason we need to rush into a change that is going to slam the city’s budget that hard,” said Greenwood, who was elected to the board by civilian city employees.

[…]

The issue of pension system earnings was raised earlier this year by the LA 2020 Commission, a 13-member group of business, union and civic leaders convened by Council President Herb Wesson. (The commission’s co-chairman, Austin Beutner, is now publisher of The Times.)

In a report released in April, the commission said the city’s pension earnings assumptions should be significantly decreased, so that they are in line with the earnings forecast of Warren Buffett’s company, Berkshire Hathaway.

The commission raised the possibility of a 6% yearly earnings assumption in its report. City Administrative Officer Miguel Santana, the high-level budget official, responded at that time by warning that such a move, if carried out for public safety and civilian workers, would rip a $566-million hole in the budget.

The retirement board initially deadlocked on the proposal to scale back its earnings assumptions. Two weeks ago, pension board member Nilza Serrano said she worried about putting additional pressure on the budget. During the meeting, she walked out of the room to avoid having to cast a vote, leaving her colleagues unable to muster a majority to make the change.

On Tuesday, Serrano reversed course and voted for the reduction, saying she had reviewed the proposal more carefully.

“I got educated,” said Serrano, a Garcetti appointee.

The decision has budgetary implications for the city, because a lower return assumption forces the city to set aside more money for retirement benefits. From the LA Times:

That decision could make it harder for Mayor Eric Garcetti and the City Council to restore services trimmed during the recession, since it forces them to set aside more money in the short term for retirement benefits.

[…]

Budget officials now expect a $165-million shortfall next year and have not factored in the pension board’s changes. The board’s consultant had warned that a failure to reduce the investment return assumption now would only force the city’s budget to pay more later if earnings fall short.

The retirement fund relies on three sources of revenue to cover pensions and healthcare for retired civilian city employees: contributions from workers’ paychecks, money taken from the city’s budget and earnings on the system’s $13.9-billion investment portfolio. When investment returns fall significantly below the agency’s projections, the gap has to be made up by the city budget, leaving less money for taxpayer services.

The board’s vote was opposed by the Coalition of L.A. City Unions, which represents about 20,000 city workers — and is now in salary talks with the city. Both the coalition and Councilman Paul Koretz portrayed the move as unnecessary, since the pension fund had strong investment earnings in recent years.

“This makes it more likely that it will be difficult to give employees any kind of a cost-of-living increase … and more likely that we will provide much fewer services than we would otherwise,” Koretz said.

LACERS manages $13.9 billion in assets.

Mississippi PERS Reports Boost in Funding Ratio, Drop in Liabilities

Actuaries for the Mississippi Public Employees Retirement System (PERS) reported during a board meeting Tuesday that the system’s funding ratio had risen from 57.7 percent to 61 percent during the course of fiscal year 2013-14, which ended on June 30.

The actuaries also reported that unfunded liabilities had dropped for the first time in at least 10 years.

From the Associated Press:

With stock market gains replacing steep losses in the accounting ledger, Mississippi’s main public employee pension fund posted stronger results last year.

Actuaries reported yesterday to the board of the Public Employees Retirement System that the funding percentage — the share of future obligations covered by current assets — rose to 61 percent as of June 30 from 57.7 percent on the same date in 2013.

The unfunded accrued liability, the amount of money that the system is short of being fully funded, fell last year for the first time in at least a decade, from $15 billion to $14.4 billion.

The system now projects that at current contribution levels, it will take 29.2 years to pay off the unfunded liability, down from a 32.2-year projected repayment period in June 2013.

PERS Executive Director Pat Robertson said the improvement supports the argument that the pension system can reduce its shortfall with time.

“I think it means that as we’ve indicated in the past, that time and patience will help get us back on the right path,” she said. “Our focus is long-term and our investments on a long-term basis will sustain the plan.”

The improvement comes, in part, because the fund’s 5-year smoothing period ended in fiscal year 2013. From the Associated Press:

The improvement stems from recent stock market gains as well as the end of an accounting period covering losses from the 2008-2009 stock market meltdown.

Like most pension funds, actuaries smooth out gains and losses over five years, booking 20 percent of the gain each year. Parceling out gains and losses is meant to reduce the volatility of market returns. In the 2012-2013 year, the system booked the last of five $1.05 billion losses from the 2008-2009 stock market meltdown.

Without that drag on results, the smoothed, actuarial value of the fund went up to $22.6 billion. Without such smoothing, the fund was in reality worth $24.9 billion at June 30, aided by an 18.7 percent investment gain in the previous 12 months. The fund has now achieved above its long-term goal of 8 percent gains in four of the last five years, giving it a tail wind for actuarial purposes in coming years, even if the stock market continues its recent decline.

“Even if we had a loss this year, we have some reserves from those gains that just happened,” actuary Edward Koebel told the board.

PERS will not be decreasing contribution rates for employees or governments as a result of the funding improvement. That’s because contribution rates were frozen by the PERS board in 2012 in an effort to pay down the system’s shortfall more quickly.

PERS manages $25.4 billion in assets.

Maryland Pension Fires REIT Manager, Will Transfer $311 Million Portfolio To New Firm

The Maryland State Retirement and Pension System is shaking up its domestic REIT portfolio as the fund has fired LaSalle Investment Management and will shift its $311 million domestic REIT portfolio to State Street Global Advisors.

From IPE Real Estate:

Maryland State declined to comment or provide a reason for the decision, while LaSalle failed to respond.

The $311m (€244m) domestic REIT portfolio will be transferred to State Street Global Advisors (SSgA), with a global investment strategy for REITs, benchmarked against the FTSE/EPRA NAREIT Developed Index.

Maryland State said it had a long relationship with SSgA across passive equities, core fixed income and EMD.

The pension fund also uses Morgan Stanley as a global REIT manager for a $387.6m foreign portfolio, also benchmarked against the FTSE/EPRA NAREIT Developed Index.

Maryland State has approved a $50m commitment to CBRE Strategic Partners US Value Fund VII.

CBRE Global Investors is raising $1.5bn for the US-focused fund, in which it will co-invest a maximum $30m.

The fund, which will invest in the office, industrial, hotel, retail and apartment sectors, has a targeted 15% gross IRR and a 12.8% net.

The pension fund has made nearly $280m in commitments to CBRE Investors since 2007.

The Maryland State Retirement and Pension System manages nearly $45 billion in assets and allocated 6.9 percent to real estate.

Chicago Teacher’s Pension Executive Director Resigns

Kevin Huber, the executive director of the Chicago Public Schools Teachers’ Pension & Retirement Fund, has announced his plans to resign from the fund. From a fund press release:

Kevin B. Huber, executive director of the Chicago Teachers’ Pension Fund (CTPF) submitted his resignation and will leave the fund effective December 31, 2014. Huber joined the fund as Chief Financial Officer in 1999, and was promoted to Executive Director in 2005. He has been on medical leave since May 2014.

“Our Trustees thank Mr. Huber for the outstanding leadership and guidance he has provided our fund during the past 16 years. As CFO and then as Executive Director, he has worked tirelessly on behalf of our members and our staff, and has set a high standard for our fund,” said Jay C. Rehak, president of the CTPF Board of Trustees. “He brought a rare combination of professional and interpersonal skills to this position and we will miss him greatly.”

The Board of Directors has initiated a national search for candidates to fill Huber’s position, and is working with executive search firm EFL Associates. The fund’s current Interim Executive Director, Peter A. Driscoll, will stay on with the fund through March 31, 2015, to ensure a smooth transition.

CTPF manages just under $11 billion in assets.

Chart: Alternatives Set To Double By 2020

A report recently released by PricewaterhouseCoopers finds that alternative assets held by the world’s largest asset managers will double by 2020 — a trend that will be driven largely by pension funds.

The makeup of alternative assets currently:

Chart credit: Chief Investment Officer and PwC

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