Ted Ballantine | Pension360

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.

Will Pension Funds Have to Foot Bill For PE Firms in Collusion Settlement?

In September, seven investment firms ended a years-long lawsuit by agreeing to a $590 million settlement with corporate shareholders who were accusing the firms of colluding to keep prices down during the “buyout boom”.

But for pension funds, the ramifications of the settlement are just beginning as they wonder how the costs of the settlement will be divided among the investment firms and their limited partners.

From the Wall Street Journal:

The California State Teachers’ Retirement System is in ongoing discussions with private equity firms involved in a collusion case about how the costs of the settlements will be shared with limited partners, said Christopher J. Ailman, the pension system’s chief investment officer.

At the center of these discussions is where the responsibility for making the settlement payments lies–in the funds from which the firms made the investments or the firms themselves–and if both are responsible, how the payments and related legal fees should be split.

“That’s still being discussed,” said Mr. Ailman. “Different firms are taking different tacks.”

[…]

Mr. Ailman called the suit “frustrating” and blamed the case on the practice of frivolous lawsuits being made against corporate acquirers.

“It’s disappointing that there are still lawyers chasing after these funds,” said Mr. Ailman, adding that the collusion suit, “in particular, is frustrating because we think it’s without merit.”

Mr. Ailman said that in general, fund documents stipulate clearly that any legal expenses related to fund investments should be covered by the fund. But that shouldn’t entirely absolve the private equity firm that manages the fund because as the general partner, the firm has a fiduciary duty toward its investors.

“I always say to my GPs that ‘What’s written there is the bottom-line agreement,’” said Mr. Ailman. “‘We [also] shook hands and have an intellectual agreement. You are my agent. You are the fiduciary to us. We invest together.’”

More background on the settlement, from the WSJ:

The lawsuit, filed by certain shareholders of companies that were acquired during last decade’s buyout boom, alleged that the firms-Blackstone Group, Kohlberg Kravis Roberts & Co., TPG Capital, Carlyle Group, Bain Capital, Goldman Sachs Group Inc. and Silver Lake-colluded to keep prices down while bidding for companies during that time frame.

By early September, all seven firms had settled with the plaintiffs, ending a seven-year litigation process and making the firms liable for a total of $590.5 million in settlement payments.

All the firms in the lawsuit denied wrongdoing and said they decided to settle the case to avoid further distraction and litigation expenses.

Pension Funds: Hedge Funds Should Meet Benchmarks Before Charging Fees

Pension funds and other investors called for changes Tuesday in the way hedge funds charge fees.

The proposed changes were outlined in a statement by the Alignment of Interests Association (AOI), a hedge fund investor group to which many pension funds belong.

The group said that hedge funds should only charge performance fees when returns beat benchmarks, and that fee structures should better link fees to long-term performance.

More details from Bloomberg:

The Teacher Retirement System of Texas and MetLife Inc. are among investors that yesterday called on managers to beat market benchmarks before charging incentive fees in a range of proposals that address investing terms. Funds should base performance fees on generating “alpha,” or gains above benchmark indexes, and impose minimum return levels known as hurdle rates before they start levying the charges, said the Alignment of Interests Association, a group that represents investors in the $2.8 trillion hedge fund industry.

“Some managers are abiding by the principals to some extent but we are hoping to move everyone toward industry best practices,” said Trent Webster, senior investment officer for strategic investments and private equity at the State Board of Administration in Florida. The pension plan, a member of the association, oversees $180 billion, of which $2.5 billion is invested in hedge funds.

[…]

To better link compensation to longer-term performance, the AOI recommended funds implement repayments known as clawbacks, a system in which incentive money can be returned to clients in the event of losses or performance that lags behind benchmarks. The group said performance fees should be paid no more frequently than once a year, rather than on a monthly or quarterly basis as they are at many firms.

AOI also called on the hedge fund industry to lower management fees – or make operating expenses more transparent so higher management fees can be justified. From Bloomberg:

Management fees, which are based on a fund’s assets, should decline as firms amass more capital, the investor group said.

“We need good managers, not asset gatherers,” Webster said. “The incentives are currently skewed.”

[…]

Firms should disclose their operating expenses to investors so they can assess the appropriateness of management fee levels, the group said.

“Management fees should not function to generate profits but rather should be set at a level to cover reasonable operating expenses of a hedge fund manager’s business and investment process,” the AOI said.

The fees should fall or be eliminated if a manager prevents clients from withdrawing money, according to the group.

Hedge funds typically utilize a “2 & 20” fee structure; but in the second quarter of 2014, hedge funds on average were charging “1.5 & 18”.

Photo by TaxRebate.org.uk via Flickr CC License

Brazil Fines Pension Fund Over Board Voting Violation

Brazil’s securities regulator fined one of the country’s largest pension funds Tuesday for violating rules regarding the election of board members of Brazilian companies in which the pension fund is invested.

Reuters reports:

Brazil’s securities industry watchdog CVM fined late on Tuesday the pension fund owned by workers of state-controlled oil producer Petróleo Brasileiro SA (PETR4.SA) for participating on the election of board and fiscal council members that was reserved only for minority shareholders.

In a statement, the CVM imposed total fines of 800,000 reais ($311,700) on Petros, as the fund is known. The watchdog also issued warnings to but did not fine the workers’ pension funds of state-run banks Banco do Brasil SA (BBAS3.SA) and Caixa Econômica Federal SA [CEF.UL] for the same cases.

The decision underpins the mounting conflict of interest between pension funds like Petros and the government, which joined forces in recent years to boost their decision-making power in Petrobras, as the oil producer is known, at the expense of minority shareholders.

[…]

While funds belong to workers in those state-run companies, their management is usually tapped among union members with strong ties to the government.

The hefty stakes that Previ, Petros and other funds in state companies have amassed in a handful of Brazilian companies for years allow them to appoint board members and key personnel.

Petros and the other two funds, known as Previ and Funcef, respectively, can appeal the CVM decision before the National Monetary Council – which is Brazil’s highest economic policy-making body.

Petros is Brazil’s second-largest pension fund.

CalSTRS Commits $290 Million to European Real Estate Funds

CalSTRS has committed $293 million to two funds that invest in European real estate. The moves are part of the pension fund’s planned third quarter real estate commitment of $900 million.

Details on the investments from IPE Real Estate:

Commitments of $200m and €75m were made to TCI Fund Management’s Real Estate Partners Fund I and Meyer Bergman European Retail Partners, respectively.

The investment in TCI Fund I, which invests in first mortgages backed by trophy assets in Western Europe and the US, has been placed into CalSTRS’s core portfolio.

CalSTRS said the assets backing the mortgages were the key appeal, alongside the income-producing potential of the strategy.

Net IRR for CalSTRS’s core assets is between 6% and 8%.

The commitment from CalSTRS represents 25% of TCI’s targeted $800m capital raise.

CalSTRS’s view that there is a strong market opportunity for European value-add retail was behind its decision to back Meyer Bergman.

The pension fund also cited a lack of available new development in Western Europe.

The fund will target Germany, France, the Nordics and the UK.

The two commitments, part of $900m approved for real estate during the third quarter, come alongside a $100m allocation to Pramerica Real Estate Investors’ PRISA II open-ended fund.

The $6.5bn fund has an income-generating core component and a non-core, build-to-core and lease-up component.

CalSTRS, with assets of $187 billion, is the second-largest public pension fund in the United States.

Photo by Stephen Curtin

Do Public Pensions Need Federal Regulation?

The federal law ERISA – the Employee Retirement Income Security Act of 1974 – regulates many aspects of private pension plans.

Should public pension funds be beholden to similar federal regulation? Alicia H. Munnell of the Center for Retirement Research explored this issue in a recent column published on MarketWatch.

Munnell writes:

In a recent meeting, an expert very supportive of public-sector employees raised the question of PERISA. These initials are shorthand for federal regulation of state and local pension plans—essentially extending some or all of the Employee Retirement Income Security Act of 1974 (ERISA), which covers private-sector retirement plans, to the public sector.

I had not thought about such legislation since the early 1980s, and am not sure how I feel about it. On the one hand, proposals these days with regard to federal regulation tend to have a punitive tone—focusing mainly on getting public plans to stop using excessively high discount rates. On the other hand, serious underfunding in some plans is usually the result of delinquent behavior on the part of the sponsor.

So some regulation might be helpful, particularly now that the Governmental Accounting Standards Board (GASB) has clarified that its financial reporting standards do not constitute funding policy guidance, leaving a vacuum when it comes to public pension funding policies. But it is not clear that federal legislation could actually include funding requirements.

Munnell explores the origins of ERISA, and the reasons the federal law wound up covering private plans:

Here’s what I remember from the old days. Originally, governmental plans were included along with private plans in the legislative proposals leading up to the passage of ERISA. In the end, Congress exempted public plans from the Act and instead mandated a study of retirement plans at all levels of government to determine: 1) the adequacy of existing levels of participation, vesting, and financing; 2) the effectiveness of existing fiduciary standards; and 3) the necessity for federal legislation. The study concluded that serious problems existed and that federal regulation was necessary.

The experts believed that the federal government had the constitutional authority under the Commerce Clause of the Constitution to regulate reporting, disclosure, and fiduciary standards of state and local plans. On the other hand, the imposition of funding standards might affect the fiscal operations of state and local governments in a way that could threaten the sovereignty of the states. Hence, early legislative efforts omitted any funding regulation.

Some form of public plan legislation was introduced in each of the next four Congresses. While reporting, disclosure, and fiduciary standards may sound dull and routine, the proposed federal regulation met with passionate opposition during its long legislative history in the early 1980s. Opponents claimed that most public plans were under large systems that were generally well managed, and the public sector had not seen the flood of participant complaints witnessed in the private sector. Supporters contended that major reporting and disclosure deficiencies still existed and that the problems would persist since a major conflict of interest often exists between the goals of elected officials and sound financial management. In the absence of adequate reporting and disclosure, public officials could grant generous benefit increases and shift the costs to future taxpayers.

The two sides battled it out for several years but, in the end, no legislation was enacted for the federal regulation of state and local plans. My sense at this point, three decades later, is that federal regulation would be useful given the importance of state and local plans to the economy and the well-being of millions of workers. But the effort to pass such a bill would be worthwhile only if the legislation included funding requirements. And only the lawyers know whether funding requirements could pass constitutional muster.

Read Munnell’s entire piece here.

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