Ted Ballantine | Pension360

Memphis Fund Ramps Up Risk With New Investment Strategy

It’s been brewing for months, but now the decision is unanimous: the board that governs the City of Memphis Retirement System has decided to turn to a higher-risk investment strategy involving increased allocations toward private equity, hedge funds and foreign stocks and bonds. From the Commercial Appeal:

The Memphis pension board cast a unanimous voice vote Thursday morning to shift hundreds of millions of dollars in retirement assets out of U.S. stocks and bonds and into assets with higher risk and potentially higher rewards, such as international stocks and bonds, and new investments in private equity and hedge funds.

The city would sell a large portion of its U.S. stocks and bonds and increase its holdings of foreign stocks from 22 percent of the portfolio to 31.7 percent. The fund would also invest 13.4 percent of the portfolio in bonds from abroad.

The pension fund would invest 4.4 percent of its portfolio in private equity companies and 4.2 percent of its holdings in hedge funds.

These numbers are “targets” — the actual percentage of investments in each class can change depending on various factors, such as investment performance.

Earlier this summer, the fund approved doubling its real estate allocation—from 5 percent to 10 percent.

Some members of the board wondered what would happen it the strategy turned sour. The Commercial Appeal reports:

“If we went with these changes, what’s the worst case scenario?” pension board member Derek Brassell asked before the vote.

“The worst case is the same worst case we would have with the existing portfolio. So it’s no different than it was before,” responded Lawrence H. Marino, senior vice president with the city’s investment advisory firm Segal Rogerscasey.

“What we’ve done is by diversifying, we can get lower risk with the same return, or we can get higher return with the same risk. Here we’re opting to get higher return with the same risk.”

Other experts had previously advised the fund that, though higher risk was guaranteed, higher returns were not a given.

“Only time will tell,” said Don Fuerst, senior pension fellow at the American Academy of Actuaries.

Does Rhode Island’s Pension Fund Performance Justify Its Fees?

David Sirota is shining more light on the Rhode Island pension system’s investment returns—and fees—under Treasurer Gina Raimondo. According to his reporting, the combination of fees and “below-median” returns are costing the state’s taxpayers. From Sirota:

According to four years’ worth of state financial records, Rhode Island’s pension system has delivered an average 12 percent return during Raimondo’s tenure as general treasurer. That rate of return significantly trails the median rate of return for pension systems of similarly size across the country, based on data provided to the International Business Times by the Wilshire Trust Universe Comparison Service.

Meanwhile, the pension investment strategy that Raimondo began putting in place in 2011 has delivered big fees to Wall Street firms. The one-two punch of below-median returns and higher fees has cost Rhode Island taxpayers hundreds of millions of dollars, according to pension analysts.

Under Raimondo’s watch, the state’s pension fund has adopted an investment strategy that heavily utilizes private equity, hedge fund and venture capital investments. The New York Times reported that those alternative investments constitute almost a quarter of the fund’s assets. Sirota writes:

The high fees associated with those alternative investments — costing Rhode Island $70 million in the 2013 fiscal year alone, the Providence Journal reported — are supposed to buy above-average investment performance. However, according to pension consultant Chris Tobe, the gap between Rhode Island and the median, a gap to which the fees contributed, means the state effectively lost $372 million in unrealized returns.

By way of comparison, $372 million represents more than one-half of the entire annual budget of the state’s largest city, Providence. In all, had Rhode Island’s pension system merely performed at the median for pension systems of similar size, the state would have 5 percent more assets in its $7.5 billion retirement system.

Raimondo’s office defends the investment decisions. A spokesperson told Sirota that the strategy needs to be judged over a longer timeline to more accurately assess its effectiveness.

North Carolina Fund Draws Fire For Fees, Conflicts of Interest

North Carolina Treasurer Janet Cowell is the sole trustee of the state Retirement System. That gives her power and control over the state’s pension investments that very few Treasurers share—but it also puts her in a position to take the brunt of the blame when things don’t go as planned.

Cowell is drawing an especially large amount of flak the past few months from critics condemning for her habit of accepting donations from investment firms—and then outsourcing investments to some of those same firms. Tom Bullock of WFAE reports:

During Cowell’s two successful campaigns to be North Carolina’s state Treasurer, 41 percent of her campaign donations came from out-of-state. Much of that money came from investment firms, insurance companies and lawyers…

The national average for state treasurers over the last two election cycles? Just shy of 11.5 percent.

In fact, over that same period 89 candidates vied to be a state’s treasurer. Only four had a higher percentage of out-of-state contributions. But in terms of total dollars, Janet Cowell is squarely at the top of that list.

Cowell declined to be interviewed for this story. Instead, her spokesman, Schorr Johnson, was made available.

“I’ll say that throughout Treasurer Cowell’s term in office she has been a consistent and vocal advocate for public financing for the office of state treasurer,” Johnson says.

Critics say there’s a reason for the influx of out-of-state cash (particularly from New York)—investment firms want the pension fund’s money, and Cowell is the one who makes those investment decisions.

Accordingly, Cowell is drawing fire for the fees paid to investment managers. Critics say the fund’s performance doesn’t justify the fees being shelled out—and some even claim that North Carolina is paying more fees that it’s letting on. David Sirota writes:

According to documents from the North Carolina Treasurer’s office, taxpayers paid $1.6 million in fees (or 0.7 percent of the $230 million Innovation Fund) to Credit Suisse for managing the fund last year. That, however, may not be the entire outlay on fees. As [Ted] Siedle’s report notes, the Innovation Fund directs capital through “fund of funds.” Those investments can also extract fees, which can be hidden in the lower returns passed on to investors.

Assuming these underlying funds charge the standard 2 percent management fee and 20 percent fee for investment performance, and taking into account private equity’s typical transaction, monitoring and operating fees, Siedle estimates that the fund is paying as much as $15.2 million in management fees each year (and that’s without factoring in any additional fees for investment performance). In all, Siedle estimates that since North Carolina’s Innovation Fund launched in 2010, as much as $65 million that was billed as going to local entrepreneurs may have gone to financial middlemen in the form of fees.

[…]

While there is no publicly available independently audited evidence of the Innovation Fund’s returns, fund officials said in 2013 that it had generated a 15 percent return so far. By comparison, the Russell 3000 has generated a 16.5 percent return since 2011, and the S&P 500 has shown a 58 percent return since 2011.

Ted Siedle, whom Sirota mentions above, has claimed for months that North Carolina was under-reporting the fees they paid to managers. He submitted his report to the SEC.

Photo by Emmanuel Huybrechts

Private Equity Coming to Your 401(k)?

Private equity has become a staple in defined-benefit plans around the world. But it’s becoming increasingly common for employers to phase out defined-benefit plans and shift new hires into defined-contribution systems.

Accordingly, private equity funds are now setting their sights on 401(k) plans. Daisy Maxey writes in the Wall Street Journal:

Some big names of the private-equity world are working to make private-equity funds an option in defined-contribution retirement plans, such as 401(k)s, as soon as next year.

Pantheon Ventures LLP, a private-equity fund investor overseeing $30.5 billion, is shopping its plan to offer a private-equity product to defined-contribution plans. The firm is in talks with plan sponsors, and anticipates striking a deal to bring the product to defined-contribution plans next year, says Michael Riak, head of the firm’s U.S. defined-contribution business.

…Private-equity investments are already offered within some defined-contribution plans, though that is rare and the products don’t offer daily pricing and liquidity, says David O’Meara, a senior investment consultant at Towers Watson Investment Services.

Private equity isn’t being welcomed into defined-contribution plans with open arms—plan sponsors maintain skepticism that those investments are the right fit for 401(k) plans.

But those in the private equity field think some plan sponsors will soon change their tune, especially if they’ve dealt with private equity in the course of administering defined-benefit plans. From the WSJ:

Though some asset managers, such as Pantheon, have the products ready to go, and are now looking for plan sponsors to participate, there remains some healthy skepticism within the 401(k) marketplace, he said.

“I would presume that the early adopters of private equity in defined-contribution plans would be large plan sponsors that have used private equity within their defined-benefit plans historically, and understand the asset class and how to evaluate its risks and returns,” he said.

Jacksonville Shelves Controversial Pension Appointment Bill

The Jacksonville City Council unanimously agreed yesterday night to shelve a proposal that could have given the Mayor the power to appoint a member to the city’s Police and Fire Pension Fund board. Reported by the Florida Times-Union:

A wall-to-wall crowd of police and firefighters only had to wait a few minutes Wednesday evening to learn the fate of legislation aimed at giving city leaders the ability to appoint a majority of the Police and Fire Pension Fund board.

In contrast to the debate two weeks ago, the discussion Wednesday night among City Council members only lasted long enough for City Councilman John Crescimbeni to make a motion for withdrawal of his bill.

The council agreed 18-0, resulting in a win for police and firefighters who rallied in opposition to the legislation. Mayor Alvin Brown’s aides also lobbied against the bill, arguing it might unravel a proposed package of pension reforms negotiated by Brown and the Police and Fire Pension Fund.

Crescimbeni’s bill would have scheduled a November referendum for voters to decide whether the mayor should have the power to appoint the fifth member of the Police and Fire Pension Fund board.

Currently, two members of the board are chosen by police and firefighters, two are selected by City Council, and those four members jointly pick the fifth member.

Leaders representing city firefighters applauded the council’s decision But at least part of the reasoning behind shelving the bill had less to do with pension reform and more to do with logistical issues. From the Florida Times-Union:

Randy Wyse, president of the Jacksonville Association of Fire Fighters, said the demise of the bill clears the way for City Council to consider a separate bill containing a host of changes to the police and fire pension system.

“We can move on and get true pension reform,” Wyse said after the vote.

In asking to withdraw the bill, Crescimbeni said there wouldn’t be enough time for election officials to take the procedural steps for placing the referendum on the November ballot.

Duval County Supervisor of Elections Jerry Holland has said the legislation needed to be wrapped up this week.

A handful of council members tried to pass the bill earlier this month, but the council postponed the passage of the bill in a 9-8 vote.

Pennsylvania Pension Reform Not Likely As Election Draws Closer

The election for Pennsylvania governor draws closer, but pension reform seems farther away than ever.

Gov. Tom Corbett has made pension reform his campaign cry. But he remains down in the polls as the urgency to pass pension reform dwindles around him—both from inside and outside the capitol. ABC 27 reports:

A typical late-August day and all is quiet at the Capitol.

But this silence is not golden for a governor who has criss-crossed the state begging/cajoling/shaming/pleading with lawmakers to give him pension reform.

“We have a bill out there right now that I want the legislature to come back and finish,” Governor Tom Corbett said a week after the legislative exodus in early July.

The governor has poster boards calling pensions a $50 billion problem that will burden future generations of Pennsylvanians.

There is disagreement among lawmakers on how to fix pensions and disagreement as to whether there’s even a problem.

“The word crisis is being used for ideological reasons, not any mathematical reasons,” insists Senator Rob Teplitz (D-Dauphin).

Teplitz, and most Democrats, believe the problem was created by the state failing, for years, to pay what it owed toward pensions and now it’s time to pay the consequences and pay up.

“It does feel more painful,” Teplitz said. “But just like any family that delays making its credit card payment, sooner or later you gotta make that payment.”

There’s no urgency among lawmakers because there’s not urgency among voters, said one pollster. Education funding is on the mind of the electorate, not pension reform. From the Philadelphia Daily News:

[Pollster Terry] Madonna said that for voters the pension-funding increase is “not something they relate to,” while Pennsylvania school districts raise local property taxes, lay off staff and curtail programs.

Other high-level observers agree that voters aren’t as engaged on pension issues. From ABC 27:

“It’s something that the public still hasn’t been able to get its arms around,” said Lowman Henry, a conservative commentator with the Lincoln Institute. “As a result, you’re not seeing that type of collective pressure on lawmakers that is going to push them to make what are very difficult decisions in an election year.”

The latest poll shows Corbett trailing his Democratic challenger, Tom Wolf, by 25 points. Wolf currently holds 49 percent of the vote, while Corbett holds 24 percent. Twenty-five percent of voters remain undecided.

Quitting CalPERS Comes With Price For California Cities

City officials from a handful of California cities—Canyon Lake, Pacific Grove and, most recently, Villa Park—have publicly weighed the option of leaving the CalPERS system as their memberships become more costly.

But leaving CalPERS got a lot less enticing when the cities learned about the fee that would be levied on them upon their departure—a termination fee that could be as high as $3.6 million for Villa Park alone. From Reuters:

Villa Park fears that pulling out of its contract with the California Public Employees’ Retirement System could be prohibitively expensive because of a termination fee that could exceed the city’s annual budget.

Calpers, America’s biggest public pension fund with assets of $300 billion, last provided the city with a hypothetical termination fee of nearly $3.6 million as of June 2012. The city’s annual budget is $3.5 million.

“Getting out of Calpers is like getting out of jail,” said Rick Barnett, mayor of Villa Park, population 5,800. The City Council will vote next month on a resolution to begin the process of quitting Calpers.

Calpers recently voted to raise rates roughly 50 percent over the next seven years, citing its responsibility to maintain the fiscal soundness of the fund.

Now Villa Park is following the trajectory as California cities who have tried, but ultimately declined, to leave CalPERS in the past. Reuters reports:

Two other California cities, Pacific Grove and Canyon Lake, tried to quit Calpers last year, but both balked when they learned the termination fee.

If a city quits, Calpers continues to administer pension payments for the current and retired workers already on the books at the time of termination.

To do that, Calpers generally asks for an up-front sum to pay for potential future pension costs for all current and retired workers on city rolls.

Canyon Lake, with an annual budget of $3.6 million, was handed a termination bill last year of $1.3 million.

Keith Breskin, Canyon Lake’s city manager, said: “It would have been a serious depletion on our reserves, so the city decided not to proceed.”

If a city quits, Calpers also places that city’s funds in a more conservative risk pool, which lowers the potential return rate on its investments and in turn boosts the termination fee.

Villa Park Mayor Rick Barnett said this week that the termination fee hasn’t completely deterred the city from their plan to leave CalPERS. He did, however, leave open the possibility that the termination fee would be too burdensome to even consider leaving the System.

Retirees Blast Mass. City Retirement Board For “Criminal” Cutbacks

Retirees, labor group leaders and even a city councilman are upset at the Leominster, Massachusetts Retirement Board after the Board voted to eliminate a cost-of-living increase in pension payments for the fifth straight year. Reported by the Sentinel and Enterprise:

“We think it’s unconscionable that our local retirees haven’t received a (cost-of-living increase) which they need,” Shawn Duhamel, the legislative liaison for the Retired State, County and Municipal Employees Association of Massachusetts, said Wednesday. “They are largely reliant on their pension as their sole income, so not having a cost-of-living increase for five years really hurts retirees, and we think it’s unnecessary.”

Out of 105 retirement systems in the state, Leominster is the only community to deny a cost of living increase in recent years, according to the association’s monthly newsletter. Somerville is the only other community to miss a cost of living increase dating to 1998.

Mayor Dean Mazzarella defended the retirement board’s decision not to increase benefits while it works to reinvest and fully fund its post employment financial requirements.

Critics have lashed out, in part, because the COLA denial comes in the wake of the Board’s above-average investment returns and the recent decision to lower its assumed rate of return.

The Board’s investments returned 21 percent in 2013, and the assumed rate of return was lowered from 6.5 percent to 5.5 percent. From the Sentinel and Enterprise:

If the retirement board maintained projects of 6.5 percent rate of return based on 2013 earnings the city’s post employment benefits obligation would be fully funded, Duhamel said.

Leominster should be proud of its long success, which is outperforming almost all others in the state, but instead of sharing the wealth with retirees is taking a different approach, Duhamel said.

The retirement board’s projection of lower returns puts a bigger burden on taxpayers to fund the program, Duhamel said.

The board’s rate of return on investments should justify a cost-of-living increase, said at-large City Councilor Bob Salvatelli.

“With that kind of impressive return we’re making off this thing, and not giving retirees a 3 percent raise, is criminal,” Salvatelli said. “It’s not even funny; it’s criminal.”

According to city estimates, giving retirees a 3 percent cost-of-living increase would cost the city $145,000 up front and would cost $900,000 over the life of the retirees who received it.

Pension Limbo Leaves Illinois Schools, Creditors Uncertain

The Illinois Supreme Court will soon rule on the constitutionality of the state’s sweeping pension reforms. But no one knows what the decision will ultimately look like—or when it will happen.

That uncertainty is weighing heavily on institutions that won’t know exactly what their fiscal future looks like until a court ruling comes down. From WUIS:

Tucked into the flurry of reports issued by credit rating agencies, one phrase has been appearing again and again, undercutting the financial outlook for many public schools and community colleges across Illinois. Under headings such as “Challenges” or “What could make the rating go down,” there’s often a warning along the lines of “increased budgetary pressures due to a shift in pension costs from the state.”

Tom Aaron, with Moody’s Public Finance Group in Chicago, says that’s because of “the likelihood that the state may have to search for additional pension answers.”

Despite prognostications by Quinn and others, Aaron says it’s not certain whether last year’s pension overhauls will be upheld by the Supreme Court.

“So in the event they are not, there is a risk that the state is going to have to go back to the drawing board in terms of trying to solve its pension issues,” he said.

And that could include a shift in pension costs from the state onto individual school districts, colleges and universities.

If the court overturns the state’s reform law, lawmakers will be sent back to the drawing board to draft a different set of solutions for cutting pension costs.

One proposal that gas gained steam in the past—and likely would be among the first policies proposed—is to shift pension costs from the state onto schools, colleges and universities. WUIS reports:

The cost-shift was once a key component of pension proposals. House Speaker Michael Madigan decried the “free lunch,” in which school boards set employee pay without worrying about future pension costs, since those would be borne by the state.

Even as recently as March 2014, Senate President John Cullerton mentioned it in a speech at the Union League Club of Chicago:

“We’ve suggested to the suburban and downstate areas, ‘You’ve got to start paying a little bit of your employers’ portion of the pensions.’ It’s called a cost-shift. … It’s important. This makes good public policy,” Cullerton said.

Moody’s doesn’t think schools can afford to wait. Moody’s Public Finance Vice President Rachel Cortez says the agency asks whether districts are bracing themselves for the possibility of a cost-shift:

“The stronger credits, the stronger management teams tend to be aware that that could be coming, and are preparing for it, making contingency plans,” she added.

The cost-shift would be particularly heavy fiscal burden on schools because state funding to schools has been chipped away in recent years.

New Jersey Pension Panel Reiterates That Politics “Not Part of Process”

State-level financial decisions don’t have to be political, but they often are anyway.

So when New Jersey Gov. Chris Christie put together a panel to come up with proposals for reforming the state pension system, many critics said the panel was constructed in a way that satisfied Christie’s political needs.

Columnist Charles Stile put that sentiment to paper earlier this month, and his words echoed the thoughts of many of Christie’s critics:

In reality, the nine-member panel has a short-term political objective — salvage Christie’s latest crusade to squeeze cost-saving concessions from New Jersey’s 770,000 public workers and retirees.

This new panel, whose members have résumés reaching from Wall Street to the Ivy League, will give Christie some much-needed cover, a chance to say that dramatic ideas to cut pension and retiree health benefits are not the ideas from a potential Republican presidential candidate, but the ideas of some of the nation’s best and brightest technocrats.

But Christie, as well as the panel members, have held steadfast to the idea that their proposals will be removed from anybody’s personal politics. The Star-Ledger reports:

[Panel Chair Thomas J.] Healy stressed that the commission is evenly split — three Republicans, three Democrats, and three independents — and that politics won’t be part of its process.

“We’ve got a group of people who are very smart,” he said. “We’re balanced. The two meetings and two conference calls we’ve had so far have been enormously apolitical. Which is the goal.”

[…]

Kevin Roberts, a spokesman for Christie’s office, defended the panel.

“The entire commission, Tom Healey included, is a group of extraordinarily well-respected and accomplished professionals who are free from politics,” Roberts said.

“Tom’s only charge is to take a cold hard look at the facts and he has helped call on some of the foremost experts on these matters to do just that.”

The panel has said its recommendations could come as soon as October, but it could be later. Their first report is due in September.

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