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Circuit Court Throws Wrench in Chicago Retiree Cuts

Last year, Chicago Mayor Rahm Emanuel ordered a three-year phase-out of a subsidy the city gives retirees to help pay for healthcare.

But a circuit court judge over the weekend ruled that certain retirees’ healthcare coverage is protected by the Illinois Constitution’s pension protection clause.

From the Chicago Sun-Times:

A Cook County court judge has thrown a curveball that threatens to prevent Mayor Rahm Emanuel from saving $108.7 million a year by completing a three-year phase-out of the city’s 55-percent subsidy for retiree health care.

In a 15-page ruling handed down this week, Circuit Judge Neil Cohen rejected the city’s motion to dismiss a lawsuit filed by 30,000 retirees and kept the individual pension funds on the hook as well.

More importantly, Cohen ruled that the lifetime health care coverage of 20,000 people who started working for the city prior to Aug. 23, 1989, is protected by the Illinois Constitution’s pension protection clause. It states that those benefits “shall not be diminished or impaired.”

[…]

The judge dismissed the lifetime benefits claim made by retirees who started working for the city after Aug. 23, 1989. He argued that they began working under a statute that provided benefits only for limited periods of time and that those agreements have expired.

The ruling is considered a victory for retirees hired before August 1989, even if the case still has a ways to go.

Photo by Joe Gratz via Flickr CC License

CalPERS Board at Odds With Maverick Member

From CalPERS Public Records Act summary report August 2015

Reporter Ed Mendel covered the California Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at Calpensions.com.

As one of 13 CalPERS board members, J.J. Jelincic presumably has some authority. But last June and July, he filed Public Records Act requests to force CalPERS to give him weekly reports from its federal lobbyists, much like any member of the public.

CalPERS tripled its federal lobbying force last year from one all-purpose firm, the Lussier Group, to three separate lobbying representatives for retirement policy, investment and market regulation, and health care issues.

Jelincic wanted to see what CalPERS was getting for its increased spending. So he asked for the weekly reports from the lobbyists, as specified in their contracts. But the rest of the board had decided monthly reports, also specified in the contracts, are enough, and Jelincic’s informal request was denied.

The unusual Public Records Act requests by a board member helped trigger a CalPERS governance committee discussion last month of “board member behavior” that was clearly aimed at Jelincic. (See video of meeting here.)

In addition to filing the Public Records Act requests, Jelincic was criticized by other board members for “disparaging” staff in public and taking more than his fair share of time at board meetings by asking questions.

“We need to have some kind of policy where there are some strong consequences to avoid that kind of thing from happening,” said board member Henry Jones, referring to the public records request and disparagement of staff.

Jelincic is in the rare, if not unprecedented, position of being a CalPERS employee and board member. He has been a member of the investment office since 1986 and a member of the board since 2010 after his election by CalPERS members.

During his first year on the board, Jelincic was allowed to remain on the job. He was placed on leave around April 2011 and still collects his salary, $118,000 last year according to the Sacramento Bee state worker salary database.

Because of his dual positions, three opinions from the state attorney general say he should not participate in some board discussions and decisions, particularly if they are about top executives who might affect his supervision or pay if he returns to his job.

“How can you be a fiduciary if you can’t be involved in the people running the system?” Jelincic said last week of his fiduciary duty as a trustee to manage the retirement assets of CalPERS members.

Three attorneys asked to look at the opinions agreed they are wrong, Jelincic said, and the three attorneys also agreed on a rough road for righting the wrong: “If you want to spend $60,000 and four years, we can make them go away.”

One of the well-publicized disparaging remarks about CalPERS staff came last year after the board, excluding Jelincic, selected Ted Eliopoulos to be chief investment officer, replacing the late Joe Dear.

Jelincic told Pensions and Investments that he worked under Eliopoulos in the CalPERS real estate investment unit from 2007 to 2012, and “he doesn’t have the temperament or the management skills” to be chief investment officer.

As some have noted, Jelincic was censured by the CalPERS board in September 2011 for the sexual harassment of co-workers, verbally and with suggestive looks, after first being warned about complaints in 2009 by Eliopoulos and another official.

At the investment committee in August, Jelincic clashed with the chairman, Jones, while questioning staff at length about not knowing the profit share or “carried interest” paid private equity firms, which drew some criticism earlier in the national media.

Jelincic later complained in writing that staff had been inaccurate, evasive and condescending. While not agreeing that “decorum” had been breached, Jones scheduled a meeting with top staff. Jelincic walked out when not allowed to tape it.

After four years of data-system development, CalPERS last month issued one of the first reports of total private equity fees paid by a major pension fund. But some of the luster was dimmed by the criticism for not tracking the fees earlier.

A general issue that emerged at the governance committee last month is whether a board member, who disagrees with a decision of the board majority, should make their disagreement public or pursue change internally.

Robert Klausner, CalPERS fiduciary counsel, told the board that “external” action by a member can undermine a decision or policy adopted by a majority of the board.

“To go through the Public Records Act, or ask somebody else to do it, I think it undermines again the effectiveness of the mission of the board as a whole,” Klausner said, “and I don’t think that’s consistent with good fiduciary practice.”

Klausner’s remarks were sharply criticized by Susan Webber, writing as Yves Smith at her “Naked Capitalism” website. She also wrote a critique of Klausner’s work with a Jacksonville pension system and noted his lack of a California law license.

Last week, Klausner said his firm has two attorneys licensed in California. He said his role is “best practices,” not legal advice. He offered a detailed rebuttal of Webber’s critique, saying the issue was between Jacksonville and the pension fund, not with him.

At the governance committee, board member Richard Costigan said: “The concern I have with PRAs is what the “P” stands for. It’s public. I’m surprised we are having this discussion.”

On the other hand, Costigan said, the requests can be used to “paper people to death” and slow down an organization. He said in this case he was struggling with how the information requested by Jelincic should be released.

Board member Priya Mathur said her understanding is that what Jelincic now receives are summaries of email and other informal communications between lobbyists and staff, creating more work for the staff.

Klausner said the public release of half-developed thoughts might impede fully-developed thoughts. But some may want to know the components, he said, suggesting staff, the general counsel, and board members could work on a release policy.

Jelincic reminded his colleagues that the lobbyist contracts call for monthly and weekly reports. He said he knows there are interim emails, phone calls and other contacts between the staff and lobbyists.

“Those, quite frankly, are never identified as public records,” Jelincic said. “I would never ask for them.”

In a way, Jelincic is following in the footsteps of another CalPERS employee who became a board member. William “Scotty” Rosenberg, a CalPERS retirement advisor, retired in 1991 but did not become a CalPERS board member until 1993.

A Plan Sponsor article in July 1997 said Rosenberg “likes making waves, even if his fellow board members consider him a rabble-rouser.”

Presumably not to spend less time with Jelincic, the staff was asked to propose options this month for scheduling fewer CalPERS board meetings, a move to reduce preparation time for members and staff. The board currently holds monthly three-day meetings.

Kentucky Pension Lowers Return Assumption

The board of the Kentucky State Retirement System (KRS) voted on Thursday to follow the recommendation of a consultant and lower the system’s assumed rate of return from 7.5 percent to 6.75 percent.

The lower rate puts a heavier burden on Kentucky to make full annual contributions – a task the state has struggled with in the past.

The nationwide average is about 7.7 percent, according to the Center for Retirement Research.

New York Pension Shifts $2 Billion Into Low-Carbon Index

New York’s state pension system, the third largest in the country, announced on Friday a shift of $2 billion into a low-carbon index fund developed in tandem with Goldman Sachs.

State Comptroller Thomas D. Napoli made the announcement from Paris.

Dallas Police Pension Investigating Former Top Officials Over Sour Real Estate Investments

The Dallas Police and Fire Pension System, with $3 billion in assets, is currently shouldering $8 billion in liabilities.

That’s due in part to a series of real estate investments that imploded to the tune of $96 million in losses in 2013 alone.

The officials who signed off on those investments have since been ousted. But the pension fund isn’t done with them, yet.

On Wednesday, the fund’s new executive director disclosed that she – and possibly the FBI – is investigating the former officials to “hold people civilly liable for malpractice”.

Ontario Teachers’ Pension Stocks Up on Renewables; May Draw Down Oil Holdings Long-Term

Ontario Teachers’ Chief Executive Officer Ron Mock told Bloomberg this week that that if the fund has a choice between buying a Prius or a Hummer, “we’re going to take the Prius every time.”

Of course, Mock wasn’t talking about cars: he was referring to the pension fund’s plan to increase holdings in wind, hydro and solar energy and draw down its oil holdings over the next 10 years – although Mock was adamant that traditional energy companies remain a strong investment.

From Bloomberg:

The fund has increased its holdings in wind, solar and hydro power to about C$3.5 billion ($2.62 billion) over the past three years from about nil, said Ontario Teachers’ Chief Executive Officer Ron Mock after an interview with Bloomberg TV Canada’s Pamela Ritchie.

“If we’re going to invest in something, if we got a choice between a Hummer and a Prius, we’re going to take the Prius every time,” he said, in reference to Toyota Motor Corp.’s hybrid car.

Ontario Teachers’ doesn’t want to find itself stuck with stranded energy assets, Mock said Wednesday. The Toronto-based fund prefers to invest in natural gas, and oil will become a smaller part of the portfolio over the next decade as it increases its position in renewables. The fund just appointed a vice president in charge of renewables globally, he said.

“If we have to pay pensions, we’re not going to shy away from” energy companies, he said. “This highly increased level of scrutiny around this risk component is starting to affect what we’ll invest in, who we’ll invest in, or whether we’ll walk away.”

Ontario Teachers’ isn’t rushing to divest from conventional energy holdings, which include Calgary-based producers such as Encana Corp., Suncor Energy Inc. and Canadian Natural Resources Ltd. The fund sees an opportunity to have a conversation about responsible corporate environmental stewardship, he said.

“I’d rather have a seat at the table and have a lot of influence and be able to push, than divesting and walking away because the truth of the matter is, they will find a replacement for our capital if we leave the table,” he said.

Ontario Teachers’ manages C$154.5 billion in assets.

Photo by ezioman via Flickr CC License Flickr CC License

Japan’s Pension Whale Gets Harpooned in Q3?

Leo Kolivakis is a blogger, trader and independent senior pension and investment analyst. This post was originally published at Pension Pulse.

Robin Harding of the Financial Times reports, Japan’s pension fund loses $64bn in third quarter:

The world’s biggest pension fund suffered a grim third quarter, losing $64bn — or 5.6 per cent of its value — as global stock markets fell.

Although much of the loss was likely regained as markets rallied in October, it is a reminder of the risks Japan’s Government Pension Investment Fund is taking after ramping up its equity exposure.

Results from the $1.1tn GPIF are likely to show increased volatility in the future after it changed its target portfolio to 50 per cent equity last year to boost returns and help service Japan’s rising pension bill.

“The volatility of short-term profits may have increased, but from a long-term perspective the risk of a shortfall in pension assets has decreased,” said Yoshihide Suga, the government’s chief cabinet secretary.

Most of the losses came from its holdings of domestic and international equities, which were down 12.8 and 11 per cent respectively, while domestic bonds generated a modest profit.

The losses were almost identical to the GPIF’s benchmark indices for those assets. Since the end of the third quarter, Japan’s Topix stock market index has rallied by almost 12 per cent to close at 1,580 on Monday.

Periods of loss are fairly common for the GPIF, which recorded annual declines in 2007, 2008 and 2010, but they are politically sensitive in Japan because the fund’s assets back basic pensions for most of the population.

It comes after a period of spectacular performance for the GPIF, which returned more than 12 per cent in 2014 as the yen weakened and the Japanese stock market rallied.

The results show the GPIF has largely completed its shift into equities. Equity holdings were towards the bottom of its target range, but that likely reflects the weakness of stock prices at the end of the quarter.

Its attempts to put cash into private equity and alternative investments remain painfully slow, however, with a portfolio allocation of just 0.05 per cent at the end of the quarter. That is equivalent to just $550m.

Japan is unusual in having accumulated assets to support part of its public pension system. The reallocation towards riskier securities is one of prime minister Shinzo Abe’s reforms, aimed at paying the pension bill of the world’s most elderly population, and thus relieving pressure on the public budget.

Political analysts say it has had the dual benefit of boosting the stock market, however, allowing Mr Abe to claim results for his economic programme. A series of smaller public pension funds are in the process of mirroring the GPIF’s asset shift.

Anna Kitannaka of Bloomberg also reports,Japan’s Pension Whale Stands by Stocks After $64 Billion Loss:

Japan’s giant pension manager is unrepentant after a push into equities saw the fund post its worst quarterly result since at least 2008.

There’s no reason to doubt the 135.1 trillion yen ($1.1 trillion) Government Pension Investment Fund’s investment strategy, officials said on Monday in Tokyo as they unveiled a 7.9 trillion yen loss for the three months through September. The slump was GPIF’s first negative return after revamping allocations last October, when it doubled holdings of Japanese and foreign shares.

The loss will test the resolve of the fund’s stewards and of Prime Minister Shinzo Abe, who called for the shift out of bonds to riskier assets such as equities as the government tries to spur inflation. Sumitomo Mitsui Trust Bank Ltd. and Saison Asset Management Co. say that while the public may question the safety of their pension savings, GPIF should be judged on how it meets the retirement needs of the world’s oldest population over a longer horizon.

“They will see some criticism for this. But that’s more of an issue of financial literacy,” said Ayako Sera, a market strategist at Sumitomo Mitsui Trust in Tokyo. “The liabilities of public pensions have an extremely long duration, so it’s best not to carve it up into three-month periods. However, from a long-term perspective, it’s necessary to continue monitoring whether the timing of last year’s allocation was good or not.”

The fund shifted the bulk of its holdings at a “terrible” time, just as stocks peaked, Sera said.

GPIF lost 5.6 percent last quarter as China’s yuan devaluation and concern about the potential impact if the Federal Reserve raises interest rates roiled global equity markets. That’s the biggest drop in comparable data starting from April 2008. The pension manager’s Japan equity investments slid 13 percent, the same retreat posted by the Topix index, and foreign stock holdings fell 11 percent. The fund lost 241 billion yen on overseas debt, while Japanese bonds handed it a 302 billion yen gain.

GPIF is likely to have purchased 400 billion yen of Japanese stocks and 1.7 trillion yen in foreign equities during the July-September quarter after its exposure to the asset class declined following the rout, according to Nomura Holdings Inc.

Equity Rebound

Things are looking up. The Topix rallied 14 percent since the start of the fourth quarter, while a gauge of global shares gained about 7.1 percent. As of Sept. 30, GPIF had 43 percent of its assets in equities around the world.

The asset manager “seriously considered” whether to continue with its current investment mix before deciding it’s the right approach, Hiroyuki Mitsuishi, a GPIF councilor, said on Monday. Short-term returns are more volatile these days, but there’s less risk that GPIF will fail on its long-term objective of covering pension payouts, he said. Fund executives have argued that holding more shares and foreign assets will lead to higher returns as Abe’s inflation push risks eroding the purchasing power of bonds.

“Short-term market moves lead to gains and losses, but over the 14 years since we started investing, the overall trend is upwards,” Mitsuishi said. “Don’t evaluate the results over the short term, as looking over the long term is important.”

Currency Loss

A stronger yen contributed to GPIF’s quarterly loss, with the currency gaining 2.2 percent against the U.S. dollar in the quarter.

GPIF has started to hedge some of its investments against fluctuations in the euro, which it sees declining in the short term on expectations for further central bank easing, the Wall Street Journal reported Tuesday. The fund is in a position to use hedges at any time, Mitsuishi said in response to the report, while declining to comment on whether it had.

GPIF hadn’t posted a quarterly loss since the three months through March 2014. The most recent results included returns from a portfolio of government bonds issued to finance a fiscal investment and loan program, with GPIF providing such figures since 2008. If those are stripped out, the drop was the fund’s third-worst on record, exceeded only by declines in the depths of the 2008 global financial crisis and the aftermath of the Sept. 11, 2001 terror attacks.

“They changed their portfolio knowing something like this could happen, and they’re not going to change their investment policy because of this,” said Tomohisa Fujiki, the head of interest-rate strategy for Japan at BNP Paribas SA in Tokyo. “They reduced domestic bonds and increased risk assets such as stocks, so temporary losses can’t be helped when there’s chaos in the market like in August and September.”

Public Relations

For Tetsuo Seshimo, a fund manager at Saison Asset Management in Tokyo, GPIF gets a pass on its performance given it was in line with benchmark indexes, and a failing grade on its public-relations strategy.

“If you have half your portfolio in stocks, this kind of thing can easily happen,” he said. “However, the public will probably be surprised. The issue is whether they have explained this properly — they haven’t.”

GPIF knows it needs to convince the public that it’s doing the right thing. It unveiled a new YouTube channel on Monday, which will have videos of its press conferences.

“People are probably very interested in GPIF’s results,” said Mitsuishi. “We want to directly explain to them that a long-term view is important.”

For those of you who speak Japanese, you can access GPIF’s YouTube channel here. It’s probably a good idea to have better communication for the sake of Japanese citizens who are worried about their pensions but GPIF should also post clips in English given it is the biggest pension fund in the world.

So, what do I think of GPIF’s record loss in Q3? It’s ugly but not unexpected given it’s shifting assets away from bonds to equities which are much more volatile, especially in a world of record low interest rates, QE, and high frequency trading platforms. Add to this currency losses from a stronger yen and you quickly understand why GPIF lost a staggering $64 billion in Q3.

Interestingly, Eleanor Warnock of the Wall Street Journal reports that Japan’s pension fund is starting to hedge against currency moves:

Japan’s ¥135 trillion ($1.1 trillion) public pension fund has started to hedge a small amount of its investments against currency fluctuations, according to people familiar with the matter.

Japan’s Government Pension Investment Fund started to hedge against fluctuations in the euro in the “short term” due to a negative outlook for the currency amid expectations for further easing by the European Central Bank, the people said.

The fund previously didn’t hedge any of its roughly ¥50 trillion in assets denominated in foreign currencies. A GPIF official declined to comment on whether the GPIF currently was using currency hedging or not, but said that the fund was ready to use currency hedging if deemed necessary.

The decision shows the GPIF becoming shrewder about selectively disclosing information about its investment strategy and also in trying new ways for managing risk on its massive portfolio. Concern about market impact made the fund reluctant to try such tools in the past.

The GPIF used a strategy involving a “tailor-made benchmark” to “quietly hedge” and not attract market attention, said one person with knowledge of the matter.

A rise in volatility in global financial markets has pushed some institutional investors to adopt hedging strategies. Norway’s sovereign wealth fund started hedging equity holdings against currency risk earlier this year, citing a rise in currency market volatility. In the U.S., the U.S. dollar’s gains have pushed more pension funds to adopt hedging strategies in the past year.

A strengthening of the yen helped amplify losses to the GPIF’s portfolio in the July-September quarter. The fund posted its worst performance in the quarter since 2008, as holdings fell 5.59%.

Some large pension funds and sovereign wealth funds around the world don’t hedge their currency exposure, which involves taking positions that would at least partially offset declines in the value of the currencies in which investments are held. Some investment officers believe the effects of currency movements even out over time due to their long investment time frames.

Though the GPIF’s mission is to achieve enough returns to fund pension payouts for the next 100 years, the fund usually reviews its portfolio every five years, and releases quarterly updates on performance.

Hedging could potentially allow the GPIF to soften large fluctuations in quarterly performance. A hedging strategy would also make it harder for hedge funds and other investors to analyze the impact of GPIF’s activity on foreign currency markets.

It’s true, some large pension funds and sovereign wealth funds don’t hedge their currency exposure. Case in point? The Canada Pension Plan Investment Board (CPPIB) which gained a record 18.3% in FY 2015. The value of its investments got a $7.8-billion boost in fiscal 2015 from a decline in the Canadian dollar against certain currencies, including the U.S. dollar and U.K. pound.

By contrast, PSP Investments is 50% hedged in currencies which explains part of its underperformance relative to CPPIB in fiscal 2015. Still, PSP delivered solid results, gaining 14.5% in fiscal 2015.

Of course, relative to GPIF and the Norwegian Pension Fund which is betting on reflation, CPPIB and PSP are peanuts. Interestingly, I would advise GPIF not to follow the Norway’s pension fund and finance real estate investments by selling Japanese bonds (GJBs). I’m increasingly worried about global deflation and for the life of me, I can’t understand why any of these mammoth funds who sell bonds to invest in real estate (at the top of the market).

Also, if they have to diversify out of stocks and bonds, why not take advantage of record low rates to borrow to fund these investments? Are they worried about the Fed preparing to hike rates in December? I wouldn’t worry about that, if the Fed starts hiking, it will exacerbate deflationary pressures and ensure more QE and lower rates for a very long time. Maybe that’s why some of Canada’s large pensions are leveraged to the hilt (the others wish they can but by law, they can’t).

Japan knows all about deflation. Bank of Japan Governor Haruhiko Kuroda has dismissed calls from critics to go slow on hitting the central bank’s 2 percent inflation target and stressed the need to take “whatever steps necessary” to achieve its ambitious consumer price goal. On Monday, he reinforced the need to reinflate prices as a central bank priority:

“If the BOJ were to move slowly toward achieving the price target, wage adjustments would also be slow,” Kuroda told business leaders in the central Japan city of Nagoya, home to auto giant Toyota Motor Corp.

“In order to overcome deflation — in other words, break the deadlock — somebody has to show an unwavering resolve and change the situation. When price developments are at stake, the BOJ must be the first to move.”

Japan relapsed into recession in July-September as slow wage growth and China’s slowdown hurt consumption and exports.

Consumer prices have also kept sliding due largely to the effect of falling energy costs, keeping the BOJ under pressure to expand its massive stimulus programme to meet its pledge of accelerating inflation to 2 percent by around early 2017.

Kuroda said the recent weakness in exports and output was unlikely to hurt companies’ investment appetite for now, as robust domestic demand has made the economy resilient to external shocks.

But he warned that the slowdown in emerging markets, if prolonged, could hurt business sentiment and discourage companies from boosting capital expenditure.

“We’ll ease policy or take whatever steps necessary without hesitation if an early achievement of our price target becomes difficult,” he told a news conference later on Monday.

The BOJ has recently joined government calls for firms to use their huge cash-pile to boost wages and investment, so far with limited success.

While the BOJ cannot directly influence wages, it can help push them up by reinforcing its commitment to achieve its price target, Kuroda said.

“If Japan were to emerge from deflation and see inflation hit 2 percent, it’s important that companies start preparing for that moment by investing more on human resources and capital expenditure,” he said.

He also said that while monetary policy does not directly target currency rates, the BOJ will closely monitor yen moves because of their big impact on Japan’s economy.

“What’s most desirable is for exchange rates to move stably reflecting economic and financial fundamentals,” Kuroda told business leaders.

Interestingly and quite worryingly, Japan’s central bank now owns more than half of the nation’s market for exchange-traded stock funds, and that might just be the start:

Policy makers weighing a deeper foray into equities shows how the world’s third-biggest stock market has become one of the most important Abenomics battlegrounds. The Topix index is up 21 percent since the central bank unexpectedly tripled its ETF budget almost a year ago, and Citigroup Global Markets Japan Inc.’s Tsutomu Fujita says there’s room for them to triple it again. For Amundi Japan Ltd., expanding the program would do more harm than good.

“At a fundamental level, I don’t support the idea of central banks buying ETFs or equities,” said Masaru Hamasaki, head of the investment information department at Amundi Japan. “Unlike bonds, equities never redeem. That means they will have to be sold at some point, which creates market risk.”

These desperate actions of the BoJ to slay Japan’s deflation dragon are another example of central banks trying to save the world. Will they succeed and bring about inflation? That’s what some elite funds preparing for reflation think but global bond markets are yawning and the crash in oil, gold and commodity prices certainly doesn’t bolster the case for massive inflation ahead.

So, Japan’s prime minister Shinzo Abe is taking advice from George Soros, cranking up the risk at public pensions and encouraging Japan’s central bank to do the same. So far, it’s been a losing battle and my fear is that all this government intervention will end up exacerbating Japan’s deflation and ensure the same outcome in China.

George Soros isn’t stupid. He sees the writing on the wall and I’m betting that he and his protege are taking the opposite side of the global reflation bet (I’m willing to bet the same thing for Chris Rokos who just started his global macro fund).

All this to say that losing $64 billion in one quarter isn’t a disaster for Japan’s pension whale. It got harpooned but it’s not a mortal wound. However, if my prediction of a prolonged period of global deflation comes true, Japan, Norway and all global pension and sovereign wealth funds betting on reflation are going to get decimated.

In fact, a new report by the OECD states that pension systems remain under strain in many countries amid slow economic growth and moves by governments to shore up financial stability in the wake of the global financial crisis.

Wait till the great experiment Shinzo Abe and central banks around the world adopted fails spectacularly, then you will see global pensions reeling. Enjoy the global liquidity tsunami while it lasts because when the tide goes out, deflation is going to expose a lot of naked swimmers and wreak havoc on pensions for a very long time.

Photo by Ville Miettinen via Flickr CC License

Pension Fix Stumps Kentucky Lawmakers

On Tuesday, Kentucky lawmakers met with a special task force that has been working since summer to come up with options to improve the funding and sustainability of the state’s teacher pension system.

But the meeting yielded no breakthroughs, and the debate is still stuck on one snag: to issue bonds, or not to issue bonds?

From WFPL:

If state leaders are closer to solving the crisis in the Kentucky teachers’ pension system, they’re not showing it.

On Tuesday, a bipartisan task force of legislators and advocacy group leaders was supposed to present a menu of ideas for addressing the teachers’ pension problem.

But few concrete solutions came out of the meeting, with a familiar line being drawn over whether to borrow money to shore up the system.

House Speaker Greg Stumbo, a Prestonsburg Democrat, said bonds should have a role in fixing the system.

“I haven’t heard any alternatives, if anybody else has got any other suggestions,” Stumbo said.

[…]

Owensboro Republican Sen. Joe Bowen still opposes bonding as a solution for the pension crisis.

“My position on bonding has not changed,” Bowen said on Tuesday. “I’ve not wavered one iota on the value or the validity of bonding. I absolutely do not think that should be any part of resolving this issue.”

Teachers’ pension system leaders say the state will need to pay $520 million — about 5 percent of the state’s total annual resources — to maintain current funding levels. That’s up from $380 million that the state paid this year.

Kentucky’s teacher pension system is 54 percent funded, which makes it significantly healthier than the state’s system for general employees.

Photo credit: “Ky With HP Background” by Original uploader was HiB2Bornot2B at en.wikipedia – Transferred from en.wikipedia; transfer was stated to be made by User:Vini 175.. Licensed under CC BY-SA 2.5 via Wikimedia Commons

San Diego Measure Would Funnel Pension Savings to Infrastructure Projects

San Diego officials have been tossing around several ideas for how to spend extra money resulting from smaller-than-projected pension contributions.

The latest idea: put the pension savings in a fund to be spent on the city’s infrastructure projects.

From the San Diego Union Tribune:

A new proposal would address San Diego’s crumbling infrastructure by requiring city leaders to devote future growth in sales tax revenue and all pension savings to the problem over the next 30 years.

[…]

The ballot measure would […] amend the city charter to earmark for infrastructure all future pension savings, which are expected to start sharply increasing 15 years from now as reforms kick in.

Kersey estimates this policy change would generate about $1 billion for infrastructure over the next 30 years, without any tax increases.

“This is new money to the general fund because it’s money we won’t be spending on pension obligations,” he said.

Pension savings are projected to be somewhere between $10 million and $15 million per year through the late 2020s. But that’s expected to climb significantly when Proposition B and other recent pension reforms take full effect.

For example, a projected $172 million in pension savings would go toward infrastructure in fiscal 2029 because the city’s annual pension payment is expected to drop to $83 million.

This is a ballot measure, so voters would have to approve it with a simple majority.

Photo by Elektra Grey Photography via Flickr CC LIcense

Pension Pulse: CalPERS’ Partial Disclosure of PE Fees?

Leo Kolivakis is a blogger, trader and independent senior pension and investment analyst. This post was originally published at Pension Pulse.

Dan Starkman of the Los Angeles Times reports, CalPERS fee disclosure raises question of whether private equity returns are worth it:

The nation’s largest public pension fund peeled back a layer of secrecy to reveal that it has paid private equity managers $3.4 billion in bonuses since 1990, a hefty figure sure to heighten arguments over whether the controversial sector is worth its high risk and expense.

The California Public Employees’ Retirement System said Tuesday that it paid $700 million in so-called performance fees just for the last fiscal year that ended June 30. The disclosure comes as critics increasingly question the wisdom of pension funds investing in such complicated corporate deals as start-ups and leveraged buyouts.

CalPERS officials emphasized that private equity generated $24.2 billion in net profit for the state’s retirees over the 25-year period, a strong performance that they said more than makes up for the sector’s added risk, complexity and cost.

Like many public pension funds, CalPERS has relied on the potentially large returns on private equity investments to help finance benefits for its 1.7 million current and future retirees — and to avoid turning to taxpayers to make up shortfalls.

“Returns from those sorts of investments need to be much higher than returns on assets not bearing similar risks and especially to justify such huge fees,” said David Crane, a Stanford University lecturer in public policy. “From what I read today about CalPERS’ returns on private equity, it’s hard to see that being the case.”

CalPERS’ disclosure, although not the first of its kind, is considered a landmark because of the system’s size and influence in the market. It’s expected to lead major pension funds to demand similar, or even more, disclosures from a multitrillion-dollar industry that has been insulated from calls for reform by the relatively rich returns it generates.

The California State Teachers’ Retirement System, for instance, plans to take up the issue of private equity disclosure at the system’s February board meeting.

“The CalSTRS Investment Committee has asked [its staff] for a greater degree of reporting and cost accounting information, which will require additional resources,” said Ricardo Duran, a spokesman for the nation’s second-largest public pension fund.

The bonuses, known in the industry as carried interest, don’t include annual management fees. Typically, bonuses amount to 20% of profits over a certain target on top of a 2% management fee, a formula known as 2-and-20.

Because of its size, now at about $295 billion in assets, CalPERS has been able to command a somewhat lower bonus rate of about 12%. Still, private equity’s outsized compensation system remains baffling to many.

California State Treasurer John Chiang is sponsoring legislation requiring even more extensive fee disclosure for private equity firms doing business with the state’s pension funds.

“Too much compensation information remains missing, and no amount of profit-sharing returns should cause us to turn a blind eye to demanding full transparency and accountability from firms which call themselves our partners,” Chiang said Tuesday.

“With any other investment class, it would be a no-brainer to demand full disclosure of all fees and costs.”

CalPERS officials, who ordered the review after acknowledging a need to get a better handle on private equity fees, believe they have reaped the benefits of private equity and are satisfied with the performance of the $27.5-billion portfolio, which represents 9% of the total fund.

“We have been rewarded appropriately for the risks that we took,” said Ted Eliopoulos, CalPERS’ chief investment officer.

Crane isn’t so sure. The difficulty in getting out of private equity deals and the high debt loads the sector usually carries raise questions about whether the investments are worth the inherent dangers, he said.

“If the returns were worth the leverage and liquidity risks, then such levels of fees might be worth it,” said Crane, who was an advisor to former Gov. Arnold Schwarzenegger.

The high-stakes business of buying and selling whole companies, dominated by massive global players such as Carlyle Group, Blackstone Group and Kohlberg, Kravis & Roberts, has struggled to shed a swashbuckling image that dates to its roots in the go-go leveraged-buyout boom of the 1980s.

Last week, its board agreed to cut the fund’s expected rate of return to 6.5%, from 7.5%, though in incremental steps that could take 20 years. The move drew criticism from Gov. Jerry Brown, who urged the system to cut the expected return to 6.5% over five years to curb its reliance on higher-risk investments.

Caught in the middle are taxpayers, who must make up for investment shortfalls — a challenge for communities struggling with retirement costs they said are already unsustainable.

In a recent report, CalPERS’ main consultant strongly endorsed the private equity sector, noting that it had an annualized rate of return of 11.9% over the last 10 years, compared with 6.6% for CalPERS’ stock portfolio, and that it performed better than CalPERS’ public stocks over all relevant periods.

Last year, for instance, the private equity portfolio’s 8.9% return blew away the public stock portfolio, which returned an anemic 1%.

But Eileen Appelbaum, senior economist at the Center for Economic and Policy Research, a Washington think tank, countered that CalPERS’ private equity portfolio has failed to meet its own benchmarks over the last one, three, five and 10 years, important measures that seek to account for the added risk that comes with complicated and cumbersome assets.

“Comparing CalPERS’ private equity returns with the overall returns of the pension fund and/or their target return for the pension fund is meaningless,” she said.

Steven N. Kaplan, a finance professor at the University of Chicago, cautioned that although CalPERS’ private equity portfolio has indeed beaten alternatives in the past, even after fees, studies show the rate of outperformance has slowed more recently.

“You should watch it very carefully going forward,” he said.

No doubt about it, the outperformance in private equity has slowed for all pensions investing in big funds and the reason is simple. As more and more pension money chases a rate-of-return fantasy, the returns of these funds are being diluted. Worse still, this is a brutal environment for private equity which is why all these historic returns are meaningless.

The good news is CalPERS is finally dropping its 7.5% expected rate of return to 6.5% but the bad news is that it’s doing it in incremental steps that could take 20 years. They should pass state and federal laws in the United States forcing all U.S. public pensions to slash their expected rate of return immediately to reflect reality of today’s markets.

As far as CalPERS’ private equity, Yves Smith of the naked capitalism blog ripped into their sleight of hand and accounting tricks where they claimed there are no alternatives to PE. Take the time to read Yves’ comment as she raises many excellent points about how the investment staff presented their findings in a way which makes their private equity portfolio look much better than it really is.

For example, apart from plotting private equity returns relative to CalPERS’ overall returns which was mentioned in the article above, Yves notes the following:

In addition, anyone who watches financial markets will notice that the returns from CalPERS’ “global equity” portfolio, which is the “Public Equity” shown in its slides, look peculiarly anemic. That’s because CalPERS has a 50% allocation to foreign stocks. Thus CalPERS’ global equity results are lousy due to CalPERS having a currency bet that turned out badly hidden in it. That in turn is used, misleadingly, to bolster the case for private equity. The fact that CalPERS is underperforming in public equities is a problem it needs to address directly and not use as a trumped-up excuse for not asking tough questions about private equity.

I couldn’t agree more and I actually had a chat with Réal Desrochers, CalPERS’ Head of Private Equity, long before last year when they were mulling over a new PE benchmark. I agreed with him that their PE benchmark was too hard to beat on good years but I told him that any private market benchmark should reflect the opportunity cost of investing in public markets plus a spread for illiquidity and leverage. Period. [no idea if CalPERS adopted a new PE benchmark]

Yves also raises excellent points on volatility. Basically, the volatility in private equity, real estate and infrastructure appears lower than it really is because of stale pricing due to the illiquid nature of these investments. So, anyone who buys these volatility figures on private equity or other private assets needs to get their head examined.

Where I disagree with Yves and her other experts who raise well-known critiques on private equity is that they downplay the significance of this asset class and why there are intrinsic opportunities in private markets which are not readily available in public markets.

Mark Wiseman, President and CEO of CPPIB, told me that he fully expects private markets to underperform public markets when the latter are roaring but in a bear market, he expects the opposite and over the very long-run this is where CPPIB sees most of the added-value coming from.

The key difference between big Canadian and U.S. public pensions is governance and the ability of the former to go above and beyond fund investments and co-investments in private equity and invest directly in this space, saving a ton on fees. Of course, to do so, you need to pay pension fund managers properly and get the governance right.

By the way, Yves Smith had another scathing comment on CalPERS’ board where she rightly defended board member JJ Jelincic:

The starkest proof of how CalPERS’ board is willing go to extreme, and in this case, illegal steps to defend staff rather than oversee it came in its Governance Committee meeting last month. We’ve chronicled how the board fell in line with recommendation by staff and its new, tainted fiduciary counsel, Robert Klausner, for fewer board meetings, even though CEO Anne Stausboll offered no factual support for of her assertion that her subordinates are overworked or that she has considered, much less exhausted, alternatives for streamlining the process or increasing staffing. Moreover, to the extent that board meeting take a lot of employee time, Stausboll’s stage management of the monthly board meetings via illegal private briefings is a major contributor.

In the next section of this board meeting, Klausner and most of the board participated in what one observer called a “hating on JJ Jelincic” session. Board member JJ Jelincic has engaged in what is an unpardonable sin: he asks too many questions at board meeting and occasionally requests documents from staff. If you’ve looked at board videos (as we have) the alleged “too many questions” are few in number save when staff obfuscates and Jelincic tries to get to the bottom of things.

This section of the Governance Committee meeting clearly shows that the board, aided and abetted by Klausner, is in the process of establishing a procedure for implementing trumped-up sanctions against Jelincic, presumably so as to facilitate an opponent unseating him in his next election. But Jelincic’s term isn’t up until 2018, so from their perspective they are stuck with an apostate in their ranks for an uncomfortably long amount of time. Part of their strategy appears to harass him into compliance with the posture the rest of the board, that of ceding authority to staff and conducting board meetings that are largely ceremonial. We strongly urge you to watch the pertinent portion in full, and have provide a link and annotations at the end of this post.*

And what are Jelincic’s supposed cardinal sins, aside from being too inquisitive? That of using the California Public Records Act (California’s version of FOIA) to request documents that staff refused to produce. Mind you, Jelincic has used the PRA all of three times, in #2029 on June 8, 2015, #2077 on July 14, 2015 and #2084 (a duplicate of #2077, so it is not really a separate request, as far as staff effort is concerned) on July 16, 2015. And these requests were for a small number of recent, readily accessible records. By contrast, virtually all of our Public Records Act requests have been far more difficult to fulfill, so it is hard to depict Jelincic’s modest submissions as burdensome.

And as to the other bone of contention, that Jelincic making these queries is an embarrassment to staff? Yes, as we’ll discuss in detail, staff ought to be embarrassed, since their refusal to provide information is rank insubordination and a further sign of an out-of-control organization that should trouble every CalPERS beneficiary. But if the board weren’t making a stink about Jelincic (almost certainly at the instigation of staff), it’s a virtual certainty that no one would have noticed, since the monthly PRA logs are read by hardly anyone, and certainly not reported on by the media.

So substantively, submitting a mere two Public Record Acts in response to staff intransigence has resulted in the board attacking Jelincic, when any properly-functioning board would be all over staff for their high-handedness in refusing a request for documents by a board member.

Every legal expert we’ve consulted in this matter has been appalled by the refusal of CalPERS’ staff to supply records to a board member when asked. For instance, we contacted two law professors, each at top law schools, both with considerable expertise in trustee matters. Each took a dim view of the notion that staff was trying to duck board member requests for information.

I will let you read the rest of Yves’ comment here but I contacted JJ Jelincic who sent me this reply on CalPERS’ disclosure of private equity fees and naked capitalism’s stinging comments:

The disclosure was a long time coming. It is a step in the right direction. However, it is not complete. It provides 17 years of data but only for the funds that we still have active positions in. It ignores closed funds which is where you see only realized values, not manager estimates.

It also fails to reflect the $1.2 billion in accrued carry. It ignores the $1.3 billion in net management fees CalPERS has paid in just the last 3 years. Portfolio company fees, discounts and waivers remain a black hole but the flash light will come.

I have been told it is a breach of my fiduciary duty to disparage staff so I will not comment on the Naked Capitalism story. I think there is some merit to Dan Primack’s comments on the timing.

The timing JJ is referring to was that CalPERS disclosed PE fees last week during U.S. Thanksgiving when most people aren’t paying attention. In his comment, Fortune’s Dan Primack notes the following:

The pension system, which is the nation’s largest with $295 billion in assets under management, reports that its active private equity fund managers have realized $3.4 billion in profit-sharing between 1990 and June 30, 2015. That is compared to $24.2 billion in realized net gains, which works out to an effective carried interest rate of just 12.3%. For the 2014-2015 fiscal year, the shared profit totaled $700 million on $4.1 billion in realized net gains, or a 14.6% effective carried interest rate.

For context, the industry standard for carried interest is 20%. That would suggest that CalPERS has been a savvy negotiator, but it’s also worth noting what today’s data dump is missing:

1. CalPERS only released data for active funds, as opposed to all of the private equity funds in which it has invested since 1990. Excluded are any fund positions that have been sold or liquidated. A CalPERS spokesman says: “We have limited recourse to seek the data from exited, inactive, sold, liquidated, etc. funds. We felt the best use of our time and resources was to focus on active funds – 98% of cash adjusted asset value is represented. And moving forward we will be consistent in that approach.”

2. We do not know actual carried interest structures for any of the funds, many of which might include preferred returns (i.e., hurdle rates). In other words, certain private equity funds only begin generating carry once they have returned the entire fund plus something like 8%. As such, the realized profit-sharing may be artificially low. Even without a hurdle rate, carry is rarely made effective until a fund repays its principle, meaning carried interest can be artificially low in a fund’s early years (something exacerbated by the pension system’s decision to only report active funds). This could be partially rectified if CalPERS also released data on accrued carried interest — something it requested from its fund managers earlier this year — but it is unclear if such figures will be forthcoming.

I doubt CalPERS will release data on accrued carried interest but Primack is right to point out that this disclosure is only partial and not a full disclosure of all fees paid out to active and closed funds (JJ Jelincic’s comment above highlight the same points and provides figures). He’s also right to point out the realized carry is artificially low.

To conclude, CalPERS big PE disclosure is a step in the right direction but it’s not enough. The senior investment staff need to respect their fiduciary duties and provide full disclosure on all fees and expenses paid out to active and closed private equity funds on their books. I expect the same thing from others who might follow CalPERS’ lead, including CalSTRS and even Canada’s large public pensions which typically keep this information hush and never break it down by fund and vintage year.

Photo by rocor via Flickr CC License

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