Ted Ballantine | Pension360

Pension Funds Criticize Excessive Private Equity Fees; More Look To Direct Investing

Pension fund officials from Canada and the Netherlands expressed their frustration with private equity fees during a conference this week.

The chief investment officer of the Netherlands’ $220 billion healthcare pension fund said it needs “to think about” the fees it is paying, according to the Wall Street Journal.

Ruulke Bagijn, chief investment officer for private markets at Dutch pension manager PGGM, said a Dutch pension fund for nurses and social workers that she invests for, paid more than 400 million euros ($501.6 million) to private-equity firms in 2013. The amount accounted for half the fees paid by the PFZW pension fund, even though private-equity firms managed just 6% of its assets last year, she said.

“That is something we have to think about,” Ms. Bagijn said.

Among the things pension officials are thinking about: bypassing private equity firms and fees by investing directly in companies. From the Wall Street Journal:

Jane Rowe, the head of private equity at Ontario Teachers’ Pension Plan, is buying more companies directly rather than just through private-equity funds. Ms. Rowe told executives gathered in a hotel near Place Vendome in central Paris that she is motivated to make money to improve the retirement security of Canadian teachers rather than simply for herself and her partners.

“You’re not doing it to make the senior managing partner of a private-equity fund $200 million more this year,” she said, as she sat alongside Ms. Ruulke of the Netherlands and Derek Murphy of PSP Investments, which manages pensions for Canadian soldiers. “You’re making it for the teachers of Ontario. You know, Derek’s making it for the armed forces of Canada. Ruulke’s doing it for the social fabric of the Netherlands. These are very nice missions to have in life.”

But an investment firm executive pointed out that direct investing isn’t as cost-free as it sounds. From the WSJ:

[Carlyle Group co-founder David Rubenstein] warned that investors who do more acquisitions themselves rather than through private-equity funds will have to pay big salaries to hire and retain talented deal makers.

“Some public pension funds will just not pay, in the United States particularly, very high salaries and will not be able to hold on to people very long and get the most talented people,” Mr. Rubenstein said at the conference. “I don’t think there are that many people who will pay their employees at these sovereign-wealth funds and other pension funds the kind of compensation necessary to hold on to these people and get them.”

[…]

Mr. Rubenstein had a further warning for investors seeking to compete for deals with private-equity firms. “If you live by the sword you die by the sword,” he said. “If you are going to do disintermediation you can’t blame somebody else if something goes wrong.”

Pension360 has previously covered how pension funds are bypassing PE firms and investing directly in companies. One such fund is the Ontario Municipal Employees Retirement System. The fund’s Euporean head of Private Equity said last month:

“The amount of fees that we were paying out for a fund, 2 and 20 [percentage points] and everything that goes with that, was a huge amount of value that we were losing to the fund,” Mr. Redman said. “If we could deliver top quartile returns and we weren’t hemorrhaging quite so much in terms of fees and carry that would mean that we would be able to meet the pension promise.”

Photo by http://401kcalculator.org via Flickr CC License

Norway’s Largest Pension Divests From Coal, But Sees Risks in Exiting Other Fossil Fuels

KLP, Norway’s largest pension asset manager, said it plans to divest from coal companies and increase investments in renewable energy.

The divestment from coal comes even as KLP remains heavily involved in oil and gas investments. That’s because an internal study suggested that divesting from all fossil fuel companies would pose big risks for KLP and harm future returns.

From IPE Real Estate:

It said it was doing this to contribute to the “urgently needed” switch from fossil fuel to renewable energy.

KLP defines coal companies as coal mining companies and coal-fired power companies that derive a large proportion of their revenues from coal.

At the very least, KLP will exclude those with 50% of revenues from coal-based business activities.

The names of the companies to be excluded will be published in an updated KLP list on 1 December.

KLP’s divestment from coal companies also applies to the KLP funds.

The public service pensions provider said preliminary estimates showed the divestment would lead to the sale of shares and bonds worth just under NOK500m.

[…]

The KLP Group, with total assets of NOK470bn, is already a major investor in renewable energy, with NOK19bn invested in Norway alone.

Last year, it also established a partnership with Norfund for direct investment in renewable energy and finance.

The additional NOK500m will be used for direct investments in increased renewable energy capacity in emerging economies, where KLP considers the need to be greatest.

The pension manager will not be divesting from oil and gas companies after a study suggested that doing so would diminish future returns. Details on the study from IPE Real Estate:

At present, the divestment does not apply to oil and gas companies.

KLP said this was because coal companies were considered to have the largest negative impact, both in terms of carbon emissions per unit of energy produced and local pollution in the vicinity of the coal-based facilities, even though there are significant variations between the different types of oil, gas and coal.

But KLP also said a withdrawal of investments in oil and gas companies would probably have a material impact on future returns, unlike the retreat from coal company stocks.

At the request of the Norwegian municipality of Eide, one of its customers, KLP carried out an assessment on the feasibility of pulling its investments out of oil, gas and coal companies without affecting future returns, in order to contribute to a better environment.

The report found no support for the “stranded assets” hypothesis, which posits that investments in companies with major fossil fuel reserves represent a greater financial risk than is normal for this type of undertaking.

It said: “On the contrary, a divestment from all fossil fuel companies would significantly increase KLP’s risk, particularly with respect to Norwegian shares.

“However, depending on the definition applied, divestment from coal companies alone would not represent any significant financial risk for KLP.”

KLP manages about $45 billion in pension assets.

Former Governors: Colorado Pension Benefits Are “Skewed”, Insufficient

Two former Colorado governors penned a column in Friday’s Denver Post that raised questions about whether too many employees were getting the “short stick” regarding pension benefits.

Richard D. Lamm and Bill Owens write:

The debate over the unfunded liability has overshadowed an equally critical issue.

What has gone largely unexamined — by PERA members, policymakers and the broader public — is the question of whether the state’s public retirement plan provides fair benefits to the majority of public servants and allows public entities to recruit and retain the highest-quality employees.

Given that virtually all public school teachers are PERA members — along with other state employees and many who work for Colorado municipalities and counties — this is a critically important question that impacts us all.

We put our trust and the safety of our families in the hands of these educators, state troopers, and snowplow drivers so it makes sense that we want to ensure that they’re treated fairly and that they represent the best and the brightest employees available.

The authors argue that, although Colorado’s average pension benefit appears more than adequate (over $3,000 a month), it masks the fact that many workers lose out. From the column:

Some PERA critics have argued that its benefits are too generous, outstripping what’s available to private sector employees. But the secret that goes unaddressed is that the vast majority of PERA members lose out under its current structure. For many of them, in fact, the benefits are insufficient to provide them with the retirement security they deserve.

Despite the buzz that it’s a 24-carat retirement plan, many of these public servants may end up with fool’s gold.

Why? While PERA highlights its average retiree benefits — $3,068 monthly, according to the latest data — this statistic hides the fact that a few retirees make far more than that and the vast majority make far less. Quite simply, the benefit structure, set by the state legislature, is skewed to benefit a minority of public employees at the expense of the rest.

Who are the rest who get the short stick under the current system? They’re employees who are more typical of the modern-day workforce — those who don’t stay at one job for the majority of their career. This could include those who move between the public and private sector or move in or out of Colorado, including, for example: a teacher who spends a half dozen years in the classroom before taking a private sector job; a public servant who follows his spouse out of Colorado — even if he continues a career in the public sector in another state; and a dedicated career Colorado public employee who wants to continue serving after becoming eligible for retirement.

Richard D. Lamm and Bill Owens are co-chairs of the Colorado Pension Project, “a group working to strengthen retirement security for Colorado public servants”.

Photo credit: “Denver capitol” by Hustvedt – Own work. Licensed under Creative Commons Attribution-Share Alike 3.0 via Wikimedia Commons

Moody’s: Public Pension Liabilities Declined in Majority of States in 2013

States paid more of their actuarially required contributions to their pension systems in 2013; coupled with “strong” investment performance, 27 states saw their pension liabilities decline in fiscal year 2013, according to a new Moody’s report.

From Pensions & Investments:

In a report released Thursday, “U.S. State Pension Medians for FY 2013,” Moody’s found that pension liabilities declined in 27 states, while 21 states with lagging valuations had an average increase of 38.9%. “We believe that states should continue to show improvement in their liabilities in fiscal 2014 due to continued strong investment performance,” Moody’s said in a statement.

The median annualized returns for the period ended June 30, 2014, was 16.1%.

In measuring actuarially determined contribution levels, Moody’s found that 34 states contributed 90% or higher in fiscal 2013 and 12 contributed between 60% and 90%, while only four states contributed less. New Jersey was the lowest at only 29% of actuarial determined contributions.

In terms of pension liability as a proportion of government revenue, the median ratio dropped to 60.3% from 63.9% in fiscal 2013, but 14 states were more than 100%. The highest ratios of pension liability to revenue were in Illinois (268.3%), Connecticut (236%), Kentucky (193.2%) and New Jersey (179.7%).

States with the lowest liabilities-to-revenue ratio included Nebraska (12.6%), Wisconsin (13.8%), Tennessee (20.9%) and New York (24.2%).

The report can be read here [subscription required].

First Ruling on Illinois Pension Reform Law Expected Friday

Sangamon County Judge John Belz spent Thursday hearing arguments for and against Illinois’ major pension overhaul.

On Friday, he is expected to release his ruling on the law. If he declares it unconstitutional, the debate could move to the halls of the Supreme Court sooner than later.

Video: Pension Funds Looking to Take on More Risk

In the above interview, Ian Hamilton, head of asset owners at State Street, talks about his research suggesting pension funds are looking to take on more risk to help close funding gaps.

Hamilton also touches on collaboration between pension funds and government on infrastructure projects.

Pension Watch: How Much Trouble Is Chicago In?

Over at the STUMP blog, actuary Mary Pat Campbell dove into Chicago’s pension troubles and its “asset death spiral” in a recent post.

It is reprinted below.

_________________________

Public Pension Watch: How Screwed is Chicago?

SPOILER ALERT: a lot.

Let me point out some language from a recent official report:

Going forward, the Plan’s ability to meet its return objective over the long term will continue to be challenged as invested assets are liquidated to pay monthly benefits. During fiscal year 2013, $496.3 million or approximately 9.8% of the investment portfolio was liquidated to assist in meeting benefit payment obligations. [page 7]
…..
Plan Net Position Restricted for Pension Benefits, as reported in the Statements of Plan Net Position totaled $5,421.7 million, an increase of $239.0 million or 4.6 percent from the prior year. The growth in assets would have been significantly higher if approximately $496.3 million in portfolio assets were not liquidated to supplement the disbursement of benefit payments during the year. [page 14]
…..
Having a negative impact on asset values was the need to liquidate investments to pay benefits on a monthly basis. In all, MEABF liquidated $496.3 million of investments to meet the Plan’s cash flow needs. [page 18]
…..
The Actuary projects that under the current funding policy, if all future assumptions are realized, the funding ratio is projected to deteriorate until assets are depleted within about 10 to 15 years. The current statutory funding mechanism impacts the ability to grow assets because in order to pay benefits, assets have and will continue to be liquidated.[page 20]
…..
In other words, $496.3 million had to be liquidated from the investment portfolio in 2013 to cover the shortfall. Without sufficient contributions, annual funding deficits will grow and overwhelm the Plan over time. [page 56]
…..
The current statutory funding policy impacts the ability to achieve higher returns over the long-term because it is projected that assets may need to be liquidated in order to pay annual benefits. This could result in a change in the asset allocation in the future to more liquid assets with a lower return. We recommend that the funding policy and assumed investment return be reviewed every year. If the funding policy is not strengthened to an appropriate level within the next year, the current investment return assumption will not be supportable for financial reporting purposes. [page 90]

Ah, the asset death spiral.

This is from the Comprehensive Annual Financial Report of the Municipal Employees’ Annuity and Benefit Fund of Chicago for the fiscal year ending December 31, 2013 (and 2012, but that’s an item I don’t want to touch right now.)

Let me explain the asset death spiral, which is when balance sheet weakness manifests itself in something really serious: a lack of cash flow to cover promised benefits.

Having to liquidate assets to cover cash flows is not necessarily a bad sign — if one has a decreasing liability (which means decreasing cash flow needs in the future).

This is not the case for Chicago. Nor Illinois.

One has to sell off assets when investment returns and pension contributions are too low to cover current cash flow needs. This reduces the asset amount for the pension funds…and if cash flow needs are increasing, you find that one has to liquidate more and more assets… until the fund is exhausted.

Remember that the equity markets did extremely well in 2012 and 2013…. and this pension fund had to liquidate almost 10% of its assets to cover cash flows. This is not good.

Let’s see what the incoming city treasurer has to say:

Mayor Rahm Emanuel’s choice to replace retired City Treasurer Stephanie Neely vowed Tuesday to do his part to help solve Chicago’s $20 billion pension crisis — by improving investment returns and reducing millions of dollars in fees paid to investment managers.

The full City Council is expected to ratify the appointment of Kurt Summers at Wednesday’s meeting, but the incoming treasurer is not waiting for the vote before rolling up his sleeves and getting to work.

He’s already meeting with actuaries and pouring over the books of the four city employee pension funds.

They include the Municipal Employees and Laborers funds that have already been reformed and police and fire pension funds still waiting for similar action.

In 2016, the city is required by law to make a $550 million contribution to shore up police and fire pension funds with assets to cover just 29.6 and 24 percent of their respective liabilities.

…..
“One fund is paying 80 percent more in fees. Another is paying 50 percent more. Yet, there’s one client: The city of Chicago. That’s real money. For fire, the value of that is about $2.5 million-a-year on $1 billion in assets,” he said.

“These kinds of things aren’t going to solve the kinds of holes we have. But any benefit we can find to invest more efficiently and less expensively is a benefit to taxpayers and retirees.”

Summers noted that the bill that saved the Municipal and Laborers Pension funds — by increasing employee contributions by 29 percent and reducing employee benefits — assumes an “actuarial rate of return” on investments of 7.5 percent-a-year.

That makes it imperative that the funds invest in the “right type of assets,” he said.

……
“It’s a common misconception to say, `If I invest in the markets or fixed-income [instruments], we’re gonna be protected, but real estate, private equity or hedge funds are risky.’ That’s plain wrong,” Summers said.

“The reality is, you have just as much, if not more exposure to risk and volatility in the market with investments in basic public securities than you do with alternative products meant to mitigate risk and limit volatility. That’s the business I was in — trying to do that for clients around the world.”

:facepalm:

While I don’t necessarily have an issue with public pensions investing in equities of various sorts (whether domestic, emerging economies, private, or whatever), and while I definitely have no problem with making sure public plans aren’t getting gouged in fees, the problem is not that the pension funds are in the “wrong type of assets” or that the fees are too high.

It’s that too much has been promised and too little has been paid towards those promises.

Can Chicago dig itself out of its pension hole?

Chicago’s pension debacle was largely precipitated by the fact that the payment schedule is determined by the state legislature rather than by complying with Government Accounting Standards Board (GASB) requirements. The state has a long history of exempting itself and Chicago from annual pension-contribution requirements.

According to a recent Pioneer Institute study that I mentioned in my last post here, “It is hard to imagine how Chicago can avoid a full-blown Detroit scenario … within the next 10-15 years unless the city both 1) finds a way to cut existing benefits and obligations and 2) starts contributing substantially more to its pension plans right away.”

Under state law, Chicago will be required to more than double that $476 million pension contribution by 2016, and the annual tab is scheduled to continue rising rapidly after that. The city says it can’t afford the higher contribution, but even the new payment is barely half of the $2.2 billion payment Chicago should make according to GASB rules.

The city plans to delay increasing its contributions in hopes that the legislature will enact changes to reduce the required payments. But while it’s important for the city to take the time needed to craft a comprehensive solution to its pension problem, waiting for state help doesn’t make much sense. Illinois faces the biggest pension crisis of any state, with $100 billion of its own unfunded obligations.
…..
Together with radical pension contribution increases, the city will need to significantly cut the cost of its existing obligations. If the courts find that such a move runs afoul of the Illinois constitution, Chicago will find itself a long way down the frightening path that leads to becoming the next Detroit.

Good luck with that.

I’m not seeing how they’re going to squeeze extra taxes out of Chicago residents, when one third of them are living paycheck-to-paycheck.

Viewpoint: Arizona’s Pension Whistle-Blowers Deserve State Protection

This week, Arizona’s Department of Administration agreed to pay the legal tab of four ex-employees of the Public Safety Personnel Retirement System (PSPRS).

The ex-employees are being sued by a real estate investment firm, Troon, for “defaming” the firm by raising questions about how it values assets.

The employees quit PSPRS last year in protest of the allegedly inflated real estate valuations.

The fact that the government is footing the ex-employees’ private legal bills has divided observers into two camps: the camp that believes the public shouldn’t be obligated to cover private legal bills, and the camp that thinks the state is doing a service to whistle-blowers who tried to expose misconduct within the pension system.

Here’s an editorial from the Arizona Republic editorial board, which falls into the latter camp:

It is hard to fathom that four highly educated, highly paid employees of the state’s pension system for first responders would quit their jobs in protest if they didn’t see something that raised serious concerns.

And so it is right that the state that employed them should protect them now that they are under heavy legal fire.

Last year, three investment managers and the in-house counsel for the Public Safety Personnel Retirement System made a powerful statement: They could no longer work for a system they believed had gone rogue.

The four unwittingly made themselves targets for legal action by asking serious and difficult questions about the valuation of the trust’s real-estate investments managed by Desert Troon.

They wanted to know whether the PSPRS used inflated real-estate values for Troon-managed investments to trigger bonuses.

Troon manages large swaths of trust real estate in Arizona, Colorado, Texas and Utah. In return, the trust has paid Troon at least $12 million per year. And Troon enjoys a minority-ownership stake.

As reported by The Republic’s Craig Harris, Troon-managed properties are among the poorest-performing real-estate investments for the system in recent years.

Lost value from the Troon-managed real estate is adding to the larger problem of a pension system for police and firefighters that is short more than half the money it needs to fund current and future retirement payments for those enrolled.

The trust also manages pension systems for public officials and correctional officers. Those funds, along with the others, creak under an unfunded liability of $7.78 billion.

After PSPRS investment managers Anton Orlich, Mark Selfridge and Paul Corens and in-house counsel Andrew Carriker quit their jobs, they found themselves defendants in a Troon lawsuit accusing them of engaging in a conspiracy to defame senior management at the company and the pension system.

The legitimacy of the four men’s concerns will play out over time, but those concerns can’t be called frivolous. They’ve led to a federal criminal investigation into the PSPRS. And a federal grand jury has gone after 100 trust documents, many involving Troon-related real-estate investments.

The former employees have paid dearly for sounding the siren on the state’s pension system. Legal bills have stacked up, and until recently, they did not know how much financial and emotional strain they would have to bear, given they were sued after they left the PSPRS.

Fortunately, the state has affirmed it will cover their legal defense, and there are no financial limits to that coverage. In fact, the state is required to provide legal defense for current or former employees when sued for “acts within the course and scope of employment.”

Without that protection, Arizona would be compelling silence in its employees who perceive wrongdoing in the workplace. It would also make whistle-blowers susceptible to punitive lawsuits meant to shut them up.

Unless we’re looking at the unfathomable, and these four former employees were motivated by malice when they quit their jobs, they did something courageous and decent that requires the state of Arizona to have their backs.

Kentucky Teachers Pension Presents Bond Proposals To Lawmakers

We learned on Wednesday that the Kentucky Teachers’ Retirement System (KTRS), one of the most under-funded education retirement funds in the country, was seeking funding help from the state legislature.

Now, many more details have emerged about the proposals the System has presented to lawmakers. KTRS presented lawmakers with two options. The Courier Journal has the details:

KTRS suggested Wednesday that lawmakers consider two borrowing scenarios in the 2015 legislative session, and supporters say the proposals could reduce taxpayer cost in the long run while helping the system cope with $13.8 billion in unfunded liabilities.

One option involves a $1.9 billion bond to help fully fund the retirement system for the next four years and eventually decrease annual pension costs about $500 million by fiscal year 2026.

A second option includes a $3.3 billion bond that could fully fund the system for eight years and reduce annual costs in 2026 by around $445 million.

Both plans are based on 30-year bonds with interest rates in the range of 4 percent, and either option could be funded by re-purposing debt service and revenue streams that already exist in the state budget, according to KTRS.

Beau Barnes, KTRS general counsel and deputy executive secretary of operations, said the system is not “wild about bonding.” But he argued that liabilities are growing at 7.5 percent a year and compared the proposal to refinancing a home at a lower interest rate.

“We were asked what we could do for the pension fund without requiring additional dollars out of current budgets, and these were the only things we could think of,” Barnes said. “We didn’t really see any other alternative.”

KTRS has at least one lawmaker on their side. House Speaker Greg Stumbo voiced his support for the plan, according to MyCn2 News:

“I think we need to listen very carefully to it and work with them to try to craft some form of a proposal, which hopefully we can get enough support to pass in both chambers because these market rates won’t be favorable much longer in my judgement,” Stumbo, D-Prestonsburg, said in the committee meeting, noting the Federal Reserve will likely get pressure from banks to raise interest rates as the economy improves.

“… What they’re saying is we can’t tarry. If we wait too long, we’ll lose this window of opportunity.”

KTRS manages $18.5 billion in assets.

Kentucky Non-Haz Pension Funding Falls to 21 Percent

KERS funding status — Credit: The Lexington Herald-Leader

The Kentucky Employees Retirement System (KERS-Non-Hazardous) is already notorious for being one of the worst funded pension plans in the United States.

But the situation got worse Wednesday, as KERS revealed the funding status of the plan has fallen from 23 percent to 21 percent over the course of the last fiscal year.

Retiree advocacy group Kentucky Government Retirees issued this statement:

The audit committee of Kentucky Retirement Systems learned today that the funding ratio for the pension plan covering most state employees dropped to an alarming 21 percent in the fiscal year that ended June 30. The funding ratio compares current assets to total long-term liabilities. The KERS non-hazardous fund dropped by 2.1 percentage points over the fiscal year. Meanwhile, the fund continued to lose assets in the first three months of the fiscal year. The fund held only $2.48 billion in assets at the end of September, representing a decline of $95 million. Given these alarming figures, and in view of the commendable efforts of the Kentucky Teachers’ Retirement System to secure funding for its financially challenged pension plan, we as stakeholders urge the KRS board of trustees to actively engage Frankfort decision makers in a funding solution for the nation’s worst-funded state pension plan.

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