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Would An Elected Comptroller Ease New Jersey’s Pension Pain?

Fixing New Jersey’s pension system has been the talk of the state lately, and as far as ideas go, all the usual suspects have been proposed: cutting benefits, making full actuarial contributions, transferring new hires into a 401(k)-style plan, etc.

One idea that is rarely discussed is the creation of a model similar to New York: the appointment of a comptroller to oversee and have authority over the pension system.

Under this model, the comptroller would take significant authority out of the governor’s hands regarding pension matters.

This hypothetical comptroller, if he wished, could have overridden Chris Christie’s decision to cut the state’s pension payments. More analysis from NJ Spotlight:

While New Jersey governors and legislatures have been cutting, skipping, or underfunding pension payments for the past 20 years, New York does not have a similar pension crisis because its elected state comptroller has the power not only to set the actuarially required pension payment each year, but also to require Albany’s governor and Legislature to fully fund it, according to a senior Moody’s Investors Service analyst.

New York State Comptroller Thomas DiNapoli is required to calculate the state’s pension payment by October 15 to give the governor’s office and legislative branch sufficient time to include his calculation in the budget for the fiscal year that begins the following June 30. That amount is then required to be paid into the state’s pension systems on or before March 1 — three months before the end of the fiscal year.

“In New York, the state comptroller is responsible for the entire pension system,” Robert Kurtter, Moody’s Managing Director for U.S. Public Finance, explained at a forum on pension funding at Kean University last week. “The comptroller’s power to require full pension funding has been litigated and upheld by New York’s highest Court of Appeals.

“The New York Legislature tried to underfund the actuarially required contribution, but couldn’t,” Kurtter said. “It’s a two-edged sword for New York. Their unfunded liability is low, but they don’t have a choice, even when revenues are down.”

The soundness of New York’s pension system is one of the principal reasons that the state enjoys a AA1 bond rating from Moody’s — one of 30 states in the top two rating categories — while Illinois and New Jersey are the nation’s fiscal basket cases, the only two states with lower-tier single-A bond ratings. While New York was upgraded this year, New Jersey’s bond rating has been downgraded a record eight times under Gov. Chris Christie.

But creating a comptroller position and giving it authority is a politically tricky process – because it involves not only amending the constitution, but also taking away significant power from the state’s governor. From NJ Spotlight:

New Jersey’s governor has more power over state spending than any other governor. New Jersey’s governor has unilateral authority to determine the revenue projections that determine the size of the budget — which Christie has consistently overestimated, as previous governors have when it met their political needs.

New Jersey’s governor also has the ability to make midyear budget cuts without seeking legislative approval — as Christie did when he retroactively changed the pension formula in March and cut $900 million in Fiscal Year 2014 pension payments in May.

Adding an elected state comptroller or state treasurer or establishing an ironclad requirement that the state make its actuarially required contributions to the pension system annually would require a constitutional amendment. The Democratic-controlled Legislature would need the governor’s signature to pass a new law, but not to put a constitutional amendment on the ballot — a strategy it used to bypass Christie on the minimum wage last year and on guaranteed funding for open space this fall.

Last spring, Christie cut $2.4 billion in payments to the pension system and diverted it to help balance the state’s general budget.

What Types of People Should Manage Institutional Money?

What traits does it take to be a successful manager of institutional money? A high IQ? A steady temperament? A penchant for going on lucky streaks?

Jack Gray, of the Paul Woolley Centre for Capital Market Dysfunctionality at University of Technology, Sydney, dives deep into this question in a recent article published in the Rotman International Journal of Pension Management.

From the article:

Successful investors are likely to be overweight on several the following traits:

• A paradoxical blend of arrogance, to discover and arbitrage opportunities ahead of the market, and humility, to simultaneously be skeptical about those discoveries.

• A commitment to the principle “know thyself” – for instance, recognizing when previously justified contrarianism has degenerated into unjustified stubbornness.

• The ability to make effective decisions under uncertainty, ambiguity, and pressure. A temperament that seeks comfort and stability will likely be ill-suited to investing.

• The confidence to encourage and absorb dissent yet to know when to act. Almost all organized human endeavors have at their core a paradigm of broadly agreed beliefs, stylized facts, and patterns of thought that impose a uniformity of views.

Ideas that challenge the paradigm tend to be ignored, not absorbed: Markowitz’s thesis was not rated as genuine economics, while Akerlof’s ground-breaking paper on the pricing impact of information asymmetry (Akerlof 1970) was twice rejected. Both eventually won Nobel prizes.

• The wisdom to know when to cooperate, a rare trait in a culture that has elevated competition to quasi-religious status. Much (though not all) investment information is “non-rival,” so that its value increases through sharing, as evident in open-source ventures. Yet by temperament, training, and incentives, many have an antipathy to sharing. In a study that engaged students in a game in which participants do better by cooperating, 60% of general students cooperated while only 40% of economics students did (Frank et al. 1999).

• The self-control to value patience, and so resist the short-term imperative and its eternal concomitant, being busy.

• A willingness to question and be curious, traits lacking in many boards that oversee other people’s money. After spending time embedded in American pension funds, the anthropologists O’Barr and Conley (1992) reported “a surprising lack of interest in questioning and surprisingly little interest in considering alternatives.”

Gray goes on to write that we can put people into two categories: hedgehogs and foxes. And while the investment world has plenty of the former, it is short on the latter. From the article:

Isaiah Berlin (1953) bequeathed us a crude but useful typology of people: hedgehogs view the world through the lens of a single defining, and usually substantial, idea; foxes view it through multiple lenses. Both types are needed in investing, but we are over-populated with hedgehogs who better fit compartmentalized corporate structures and are more fecund. We need more foxes, people with broader perspectives willing to trespass—a notion coined by Albert Hirschman (1981)—into foreign fields.

[…]

Cultural change is needed to recognize, support, and reward foxes, who tend to be spurned by tribal hedgehogs as soft-headed dilettantes. To Charlie Munger (1994), having different mental models is the most important thing in investing, because they expose new opportunities and drive a dialectic of risk. Investment organizations should seek more people with “contrary imaginations,” as the psychologist Liam Hudson (1967) phrases it: people with exceptional intelligence in alternative but meaningful ways; people with intelligence about the humanities, especially history and psychology, the disciplines that underlie and drive markets; people with emotional intelligence to direct and manage others; and people with organizational intelligence to get things done.

Gray provides much more analysis in the full article, which can be read here.

Photo by Nick Wheeler via Flickr CC License

Supreme Court To Hear Case on Excessive 401(k) Fees

Mutual fund fees will soon have their day in the highest court in the land.

The U.S. Supreme Court has agreed to hear a case centered on “excessive” fees collected by mutual funds in 401(k) plans. The case will also determine whether there should be a statute of limitations on lawsuits alleging fiduciary breach. From Investment News:

As a landmark 401(k) excessive fees lawsuit makes its way to the U.S. Supreme Court, industry experts say the court’s decision could set off a domino effect of changes — from the process of choosing plan funds to fiduciaries’ ability to obtain liability insurance.

The case in question is the famed Glenn Tibble v. Edison International, a suit originally filed in August 2007 in the U.S. District Court for the Central District of California. The original suit centers on six retail mutual funds in Edison’s plan menu, which were offered instead of cheaper institutional share classes.

Though the plaintiffs eventually received a 2010 judgment from the district court, they were granted only $370,732 in damages related to excessive fees in three of the mutual funds. The saga continued as both parties battled over fees, bringing the suit to the 9th Circuit Court of Appeals. Last week, the Supreme Court agreed to review the case.

Currently, the defendants are arguing a statute of limitations requires that plaintiffs bring a suit alleging fiduciary breach within six years of the last action constituting the breach.

The ruling will have big implications for retirement plans and the people that run them. From Investment News:

Though some ERISA attorneys interpreted the focus on the six-year statute of limitations as a litigation tactic, other retirement industry experts noted that where the court lands on that issue could shape how fiduciaries serve retirement plans and participants.

“The theory of open-ended liability that could be continuing: On the one hand, you might be more protective of participants, but on the other hand, it can limit the degree to which [liability] insurance is written,” said Jason C. Roberts, CEO of the Pension Resource Institute, a retirement plan consulting firm for broker-dealers.

Aside from the statute-of-limitations issue, the retirement industry will likely be shaken to its core given the fact that the highest court in the land is going to address the issue of excessive fees in 401(k)s. Greater attention to fees by the powers that be could tip the scales even more in favor of cheaper retirement plan offerings.

“It depends on what the Supreme Court is going to do: Will they answer the questions of whether there’s a bright line with institutional versus retail funds,” said Marcia Wagner, a managing director of The Wagner Law Group. “If the Supreme Court says something that clearly, I think the entire industry will move in that direction.”

“I think you’ll see the larger plans, and even the small to midsized plans, going institutional,” Ms. Wagner said. “The salient issue for the Tibble case is that the same funds were available in both institutional and retail. What’s the difference that justifies the fees?”

CalPERS Dials Up Real Estate; Will Increase Allocation By 27 Percent

CalPERS has beefed up its real estate portfolio this summer, but the fund is far from finished: by 2016, it plans to increase its real estate holdings by 27 percent.

The pension fund says real estate will largely fill the void left in the wake of its hedge fund exit.

From Bloomberg:

The California Public Employees’ Retirement System, the biggest U.S. fund, is increasing investments in real estate by about $6 billion within a year as it begins to exit hedge funds.

The $295 billion fund had 8.7 percent in real estate as of July 31. Since then, the allocation has risen to 9.9 percent, and the fund has set a target of 11 percent in fiscal 2016, according to documents posted on its website.

Calpers began restructuring its real estate portfolio after suffering a 37 percent loss in 2010, when it wrote off speculative residential investments as property values slumped. As part of the overhaul, the fund has focused on core income investments such as rental apartments, industrial parks, offices and retail space.

The shift will mean an increase in commercial real-estate investments by 27 percent, the Wall Street Journal reported.

More details on the strategy from the Wall Street Journal:

[CalPERS] is focusing on investments such as fully leased office towers and apartments in big cities, which it argues are safer because there is established demand for these properties. In another shift, the giant pension fund has been investing almost exclusively through real-estate funds that manage separate accounts created for Calpers, which offers more control over how that money is invested.

Some of Calpers’ real-estate consultants are warning that moving too much money into pricey properties could backfire. Pension Consulting Alliance Inc. cautioned in a July report to Calpers not to expect “these increases in value to be sustained when interest rates and new construction starts return to more normalized levels.”

Ted Eliopoulos, Calpers’ recently appointed chief investment officer, changed the fund’s real-estate approach in 2011, when he led that group. Since then, the fund has delivered average annual returns of 14% in its real-estate portfolio. But Mr. Eliopoulos acknowledges the recent high returns are unsustainable.

The fund’s goals now are to diversify its portfolio risk and generate steady, modest gains, rather than striving for outsize returns with more speculative bets, he said. Likewise, Calpers on Sept. 15 said it would shed its $4 billion investment in hedge funds as part of an effort to simplify its assets and reduce costs.

“Our strategy is to focus on high-quality real estate,” Mr. Eliopoulos said. “We’re still on track.”

CalPERS was a large real estate investor in the years before the financial crisis and frequently saw returns of 30 percent or more within the asset class. But the economic downturn led to losses of $10 billion, or 50 percent.

CalPERS’ CIO, Ted Eliopoulos, maintains that the fund learned from those losses and staff plan to make less speculative investments this time around.

San Francisco Pension Fund Votes Today On Whether To Invest in Hedge Funds

San Francisco Employees’ Retirement System (SFERS) will vote later today on whether to invest in hedge funds for the first time.

If the board votes “yes”, the fund will have the ability to allocate up to 15 percent of its assets toward hedge funds. Reported by Bloomberg:

The hedge fund proposal stems from a June meeting when staff recommended changes to the fund’s asset allocation and the board voted to take 90 days to study options. At a meeting last month, staff suggested shifting the allocation to invest 35 percent in global equity, 18 percent in private equity, 17 percent in real assets, 15 percent in fixed income and 15 percent in hedge funds, according to the [fund CIO] Coaker memo.

The retirement system administers a pension plan and a deferred-compensation plan for active and retired employees. Retirement members include those who had worked for the City and County of San Francisco, the San Francisco Unified School District, the San Francisco Community College District and the San Francisco Trial Courts.

Herb Meiberger, a commissioner and retirement board member, last month called for keeping hedge funds out of the mix. Hedge funds are complex, difficult to understand and carry high management fees, he said in a September memo.

“SFERS is a public fund subject to public scrutiny,” Meiberger wrote in the memo. It’s “one of the best-funded plans in the United States. Why change course?”

[…]

The San Francisco fund had $17 billion in assets based on market value and an unfunded liability of 15.9 percent as of July 1, 2013, a decline from 21.1 percent a year earlier, according to its most recent actuarial valuation report.

The chief investment officer of SFERS, William Coaker, recommended approving hedge funds in a memo this month.

“They have provided good protection in market downturns,” he wrote.

Pennsylvania PSERS Director Announces Retirement

Jeffrey Clay, the executive director of the Pennsylvania Public School Employees’ Retirement System (PSERS) yesterday announced his plans to retire. PSERS is the state’s largest public pension fund.

He’ll officially leave his position in March.

The Case Against London Mayor’s Pension Proposal

London Mayor Boris Johnson wants to merge the country’s 39,000 public sector pension plans into one scheme, which would invest in building and updating the UK’s roads, airports, railroads and other infrastructure.

Yesterday, one of the UK’s largest pension funds, the London Pensions Fund Authority (LPFA), backed the idea.

But Sean O’Grady, economics editor of the Independent, offered a counter-point recently in his column. The bottom line, he says: “Sensible pension fund managers do not send their money where politicians tell them to.” From the column:

What most sensible pension fund managers do not do is send their cash to where politicians tell them to. If they do invest in the public sector, via PFI schemes, they do so via specialist companies and private equity vehicles who have worked out how to make money out of running prisons or trains. They do not do so directly.

There are good reasons for this. Let us take a few examples from history, “investment opportunities” presented as safe, prudent and lucrative ventures that successive governments poured taxpayers money into. The Millennium Dome; The Humber Bridge; Concorde; the NHS IT project; all vastly over budget, and an utter waste of money.

Or the Advanced Passenger Train and its unique “tilt” mechanism; cost £150m and never carried a single fare. Any and every block of 1960s high-rise flats that has since had to be dynamited, though the local authorities who built them are still paying off the debt. Nuclear power stations that promised electricity that would be too cheap to bother metering. Not to mention Boris’ glass testicle, by which I mean City Hall, as it has been renamed with cruel cockney humour.

Now of course there are worthy public projects that can earn a return for investors. The point is that the best people to decide on whether to invest your hard earned cash into such schemes are not the politicians who would like to get some votes off the back of them, but the investment managers we appoint to look after our cash. Private or public sector, would you really lend Boris Johnson your life savings so he can run a tube line to Bromley? I thought not.

The Mayor originally proposed his plan in a weekend op-ed in the Telegraph, which can be read here.

Chart: How Kentucky’s Alternatives Allocation Compares To Other Funds

The Kentucky Retirement Systems, more than almost any pension fund in the country, allocates a significant chunk of its assets toward alternatives.

But how does KRS compare to other pensions funds in that area? Check out the chart above.

The data is from the Public Fund Survey, which polls 98 pension funds every year on a variety of topics, including asset allocation.

Only 4 funds in that 98 fund sample allocated a higher percentage of its assets toward alternatives than Kentucky.

Chart is courtesy of the Kentucky Center for Investigative Reporting.

Documents Shed New Light on Alleged Conflicts of Interest In New Jersey Pension System

Gov. Chris Christie has shielded his state’s pension system in recent weeks from allegations of conflicts of interest by asserting one thing: the State Investment Board doesn’t have input in pension investment decisions, it only loosely oversees them.

But new documents obtained by the International Business Times suggest that the Council does have an active hand in guiding pension money.

David Sirota writes:

The minutes of the State Investment Council (which Christie appoints, and whose official mission is to “formulate policies governing the investment of [state] funds”), show his appointees not only oversee the state’s due diligence reviews of specific managers but also offer guidance to New Jersey Treasury Department officials about managers. Christie appointees at times cast votes on specific investments and have spearheaded the recruitment and subsequent appointment of the official who runs the state’s Division of Investment.

According to minutes of the State Investment Council, most of New Jersey’s investments in private equity, hedge funds, venture capital and other so-called alternative investments are reviewed by Christie appointees on the Investment Policy Committee (a subcommittee of the State Investment Council). Typically, the minutes show State Investment Council Chairman Robert Grady reports the committee “discussed the investment and was satisfied that the due diligence that was performed was adequate and appropriate.”

Grady was appointed to the council by Christie. He also serves as the Chairman of the Governor’s Council of Economic Advisers, and state documents show he was in regular contact with Christie administration and campaign officials. The governor has described him as a longtime friend.

The State Investment Council debates the merits of specific investments in open session, offering advice to Department of Treasury staffers about the specific money manager being given a New Jersey pension contract. Because the council has influence over the selection of specific managers, Grady and another Christie appointee, real estate investor Jeffrey Oram, have recused themselves from deliberations that involve managers to whom they might have a financial connection.

The documents also reveal a few examples of members explicitly voting to approve (or disapprove) big investments with money managers. From the report:

– On Dec. 8, 2011, Grady spearheaded a proposal to invest as much as $1.8 billion of New Jersey money in the Blackstone Group. State records show “a motion was made by Chair Grady to approve the Blackstone investments,” the motion “was seconded by Council Member Oram,” and the investment in Blackstone was subsequently approved on a 7-2 vote. As IBTimes previously reported, Grady’s private firm was investing in one of the same Blackstone funds though Grady did not disclose that at the time of the vote.

– On July 21, 2011, the council voted on a quarter-billion-dollar investment in Blackstone Resources Select Fund. After a debate, the council voted against a motion to halt the investment.

– On June 11, 2011, the council voted to approve a financial maneuver to facilitate a specific transaction with a firm called RLJ Lodging Trust.

In addition to overseeing and voting on specific investments, Christie appointees oversee the appointment of the state official who runs the state’s Division of Investment.

Christie yesterday offered his first extensive defense against conflict of interest allegations.

Photo by Truthout.org via Flickr CC License

Research Shows Pension Funds Are Biggest Owner of Alternatives Among Institutional Investors

New research from Towers Watson reveals that pension funds are the largest buyer of alternative investments among institutional investors (a designation that includes insurance companies, banks, endowments, etc.).

The research also details the rapid rise of alternatives as a major part of pension fund portfolios—globally, alternatives make up 18 percent of pension portfolios. That number has more than tripled since 1999, when pensions allocated 5 percent of assets toward alternatives.

From HedgeCo.net:

The research — which includes data on a diverse range of institutional investor types — shows that pension fund assets represent a third (33%) of the top 100 alternative managers’ assets, followed by wealth managers (18%), insurance companies (9%), sovereign wealth funds (6%), banks (3%), funds of funds (3%), and endowments and foundations (3%).

“Pension funds continue to search for new investment opportunities, and alternative assets have been an area where they have made, and continue to make, very significant allocations. While remaining an important investor for traditional alternative managers, pension funds are also at the forefront of investing in new alternatives, for example, in real assets and illiquid credit. But they are by no means the only type of institutional investor looking for capacity with the top alternative managers. Demand from insurers, endowments and foundations, and sovereign wealth funds is on the rise and only going to increase in the future as competition for returns remains fierce,” said [Towers Watson head of manager research Brad] Morrow.

[…]

“Pension funds globally continue to put their faith in diversity via increasing alternative assets to help deliver more reliable risk-adjusted returns at the total fund level. This is evidenced by the growth, significant in some instances, in all but one of the asset classes in the past five years. Most of the traditional alternative asset classes are no longer really viewed as alternatives, but just different ways of accessing long-term investment themes and risk premiums. As such, allocations to alternatives will almost certainly continue to increase in the long term but are more likely to be implemented directly via specialist managers rather than funds of funds, although funds of funds will also continue to attract assets, as borne out by this research,” said Morrow.

The research was part of the Global Alternatives Survey, an annual report produced by Towers Watson.

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