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Illinois Governor, Challenger Spar over Pension Links to Cayman Islands

It’s become a tradition for politicians of either party: on the campaign trail, at some point, you need to accuse your challenger of dodging taxes. The race for Illinois governor is no exception, but there’s an interesting spin on this one.

Current Illinois Gov. Pat Quinn earlier this week accused wealthy challenger Bruce Rauner of dodging U.S. taxes by placing his money in offshore accounts in the Cayman Islands.

A Chicago Tribune investigation had previously revealed that Rauner paid a tax rate of around 15 percent on much of his fortune, even though his wealth made him eligible for tax brackets above 30 percent.

But Rauner fought back, first claiming that his offshore investments did not impact the tax rate he paid. Then, he claimed Quinn himself had money in the Caymans. His pension, to be exact.

Rauner claims that Illinois pension funds have hundreds of millions of dollars in Cayman-based investments.

From the Chicago Sun-Times:

Rauner’s campaign said the Teachers Retirement System has invested $433.5 million in Cayman Islands-based funds while the State Board of Investment has $2.3 billion in offshore holdings, which includes some Caymans-related funds though the agency could not specify how much.

Both are tax-exempt entities and, unlike individual investors, derive no direct tax benefit from investing in funds based there, spokesmen for both agencies said. TRS invests on behalf of current and retired suburban and downstate teachers. The State Board of Investment oversees pension investments for current and retired state workers, university employees, judges, lawmakers and state officials, including the governor.

“If Pat Quinn refuses to apologize and tell the truth, he should immediately move to divest all state investments from companies and funds domiciled overseas, including in the Cayman Islands,” Rauner’s campaign said.

As was bolded, pensions systems are tax-exempt and so there’s no tax benefit from putting money offshore.

Quinn’s camp, when pushed for a statement, declined to say whether Quinn would like the pension systems to stop investment in Cayman-related funds. But the Governors spokeswoman told the Sun-Times:

“The governor has no authority to direct pension fund investments, and he’s not about to start getting involved. That’s really not the issue.”

Why Did Ontario Lawmakers Wait So Long to Release A Report Critical of Its Pension Systems?

There’s been much concern in Ontario about the sustainability of its public pension systems, particularly in the electricity sector. Ontario Auditor General Bonnie Lysyk warned in 2013 that electricity sector pensions were unsustainable and quite possibly too generous.

Union leaders, taxpayers and other concerned parties agreed that the systems deserved a closer looking-at.

So, last December, Ontario lawmakers appointed Jim Leech—former head of the Ontario Teachers’ Pension Plan—to examine the pension systems inside and out to produce a report and make recommendations to improve their sustainability and affordability.

On March 18, 2014, the report was delivered to Ontario lawmakers. But not to the public.

For over four months it didn’t see the light of day. But last Friday, August 1, the report was finally released to the public. And it was highly critical of the sustainability and cost of the electricity sector’s public pension plans.

[The entire report can be read at the bottom of this page.]

From the Toronto Star:

As reported by the Star’s Rob Ferguson, the 45-pagestudy by former Ontario Teachers’ Pension Plan head Jim Leech finds that Ontario taxpayers contribute $5 for every $1 employees are putting into their pension plans at Hydro One.

Ontario Power Generation isn’t much better, with employees contributing just 24 per cent of contributions compared to 76 per cent by the publicly owned utility.

Meanwhile, compared to other public-sector plans, the ones at Ontario’s four electricity agencies are “generous, expensive and inflexible,” Leech wrote.

What’s more, the study found all four pension plans “are far from sustainable.” Wrote Leech: “Should plans go further into deficit, the sponsors and, ultimately, ratepayers will be required to pay even larger contributions.”

The report has already accomplished part of its purpose: get the government thinking about ways to make these systems more sustainable and less costly.

But new questions are being raised about the transparency issues surrounding the report’s release. Although lawmakers saw the report in March, the public had to wait. Why was it allowed to gather dust for nearly five months?

Other stakeholders are wondering the same thing. Some reactions, as reported by The Star:

“This is awfully suspect,” said Progressive Conservative MPP Vic Fedeli, his party’s finance critic, questioning Wynne’s oft-stated goal of running an “open and transparent” government.

“There was ample opportunity to release this document with good public scrutiny. What are they hiding? What didn’t they want us to know?”

Also:

“Why now, why not before the election so people would have known what’s happening?” said Plamen Petkov, whose lobby group opposes the ORPP as too expensive.

“We’re very worried to see government agencies where employees are paying only 20 cents on the dollar for their pensions when taxpayers pay the other 80 cents. No wonder the government itself expects electricity prices to go up 42 per cent over the next five years,” he told the Star.

“It’s really disappointing. We recommend the government clean its own house first before they ask employers to contribute $3.5 billion a year to the Ontario Retirement Pension Plan.”

Government officials said they originally planned to release the report on May 1, when Ontario’s new budget was passed. But the budget wasn’t passed, and that led to new elections being held.

The report was held as elections played out. The results of those elections weren’t confirmed until June 24^th. Still, the report remained in the hands of the government for another 5 weeks afterward.

Here is the report, which can also be found on Ministry of Finance website.

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Photo: “Ontario-flag-contour” by Qyd. Licensed under Public domain via Wikimedia Commons

Six Years Later, Warren Buffett Is Winning His Bet Against Hedge Funds

In 2008, Warren Buffett made a $1 million wager with alternatives firm Protégé Partners. The money came from Buffet’s own pocket, not Berkshire’s. Around the country, the ears of pension funds began perking up in anticipation. The bet:

“Over a ten-year period commencing on January 1, 2008, and ending on December 31, 2017, the S&P 500 will outperform a portfolio of funds of hedge funds, when performance is measured on a basis net of fees, costs and expenses.”

In other words, Buffett bet that, taking into account investment expenses, an index fund would outperform a fund of hedge funds over a ten-year period. The thinking is in line with what Buffet has publicly said in the past. And, six years later, Buffett is winning his bet.

(The winner of the bet, by the way, will donate the money to a charity of his choice).

This bet is of particular interest to pension funds because alternative asset classes have increasingly become part of their investment portfolios. Regardless of who wins the bet, however, the results will be largely symbolic.

But the over-arching philosophies behind the wager are still interesting to examine. For Buffett, his dislike of hedge funds comes down to fees.

Costs skyrocket when large annual fees, large performance fees, and active trading costs are all added to the active investor’s equation. Funds of hedge funds accentuate this cost problem because their fees are superimposed on the large fees charged by the hedge funds in which the funds of funds are invested.

A number of smart people are involved in running hedge funds. But to a great extent their efforts are self-neutralizing, and their IQ will not overcome the costs they impose on investors. Investors, on average and over time, will do better with a low-cost index fund than with a group of funds of funds.

On the other end, Protégé Partners defends hedge funds:

Mr. Buffett is correct in his assertion that, on average, active management in a narrowly defined universe like the S&P 500 is destined to underperform market indexes. That is a well-established fact in the context of traditional long-only investment management. But applying the same argument to hedge funds is a bit of an apples-to-oranges comparison.

Having the flexibility to invest both long and short, hedge funds do not set out to beat the market. Rather, they seek to generate positive returns over time regardless of the market environment. They think very differently than do traditional “relative-return” investors, whose primary goal is to beat the market, even when that only means losing less than the market when it falls. For hedge funds, success can mean outperforming the market in lean times, while underperforming in the best of times. Through a cycle, nevertheless, top hedge fund managers have surpassed market returns net of all fees, while assuming less risk as well. We believe such results will continue.

Pension360 has covered the emerging trend of pension funds, including CalPERS, reducing their investments in hedge funds.

Photo by Fortune Live Media via Flickr CC

Argentina Default Devastates Pensions of Brazilian Mailmen

Argentina’s failure to pay interest on its debt—resulting in the country’s second default in 13 years—was always going to have an economic ripple effect.

But Brazilian mailmen probably didn’t realize they’d be near the top the list of negatively affected parties. In light of Argentina’s default, they’ve seen their pensions zapped.

That’s because Postalis, the pension manager to which about 130,000 active and retired Brazilian postal workers belong, is feeling the pain of the default.

Postalis was invested in the fund Brasil Sovereign II Fundo de Investimento de Divida Externa, a Brazil-based investment fund of Bank of New York Mellon, that this week wrote down its assets by 51 percent, according to Bloomberg:

Bank of New York Mellon Corp. said one of its Brazil-based investment funds wrote down more than half the value of its assets after recording losses on investments linked to Argentine government debt.

The Brasil Sovereign II Fundo de Investimento de Divida Externa FIDEX took a loss of 197.9 million reais ($87.2 million) on Aug. 1 after booking a provision on credit-linked notes tied to Argentine bonds, according to a regulatory filing yesterday by BNY Mellon DTVM, the bank’s Brazilian fund manager. The fund has just one investor and the identity is not public information, according to securities regulators.

Argentina last week failed to make a $539 million interest payment on its bonds, prompting Standard & Poor’s and Fitch Ratings to declare the country in default for the second time since 2001. The country has about $29 billion of overseas foreign-currency notes outstanding, and the International Swaps & Derivatives Association ruled last week that the failure to pay interest will trigger $1 billion of credit-default swaps.

“Due to the suspension of payment on foreign debt notes issued by Argentina backing the referred notes, and to the necessity to change its evaluation methodology of some credit-linked notes, provisions for losses have been made in its portfolio,” BNY Mellon DTVM said.

The fund that held the notes had 384.4 million reais worth of assets as of July 31, according to data available at the website of the Brazilian securities regulator. The value dropped about 52 percent to 185.5 million reais as of Aug. 1.

You’ll notice in the excerpt above that the fund has only one investor, the identity of which isn’t public information. But it’s widely believed that investor is Postalis. From Businessweek:

While the statement didn’t identify the entity that is the fund’s sole investor, all signs point to Postalis, the pension manager serving about 130,000 current and former postal workers in Brazil.

Postalis, which had 8 billion reais ($3.5 billion) in assets according to the latest data available, said in statements as early as 2011 and as recently as May that it had invested in the fund. Postalis’s press office declined to comment.

Postalis is Brazil’s 14th-biggest pension group by investments under management, according to June 2013 data available from the Brazilian pension association Abrapp.

Brazil’s pension regulator was asked by multiple media outlets to comment on the situation, but has so far declined all requests.

Photo: “Argentina Logo” by Guillermo Brea. Licensed under Creative Commons

In Illinois, Public Pension Benefits Are Gaining Ground On Worker Salaries

Over the past decade, the average public pension in Illinois has been gradually catching up to the average salary of employees still working.

Critics of increased benefits say this is the result of years of generous salary increases and compounded COLA increases.

Others say that increased pensions are simply the result of higher public sector salaries, which Illinois needs to pay in order to retain good employees.

The Daily Herald reports:

The average 2013 pension was $31,674 for retirees in nine statewide and metropolitan Chicago public pension systems for government workers, teachers, legislators, judges and university professors, a Daily Herald analysis shows. That’s 60 percent of the $55,120 average salary for pension fund members who are still working.

Ten years ago, the average pension was less than half of the average salary.

…

The narrowest gap between average salary and average pension is for members of retirement systems where advanced degrees and training are required.

In 2013, the average Teachers’ Retirement System pension was 69.4 percent of the average pay for those still working, according to the system’s annual comprehensive financial report.

Judges have the highest average salary — $183,998 — and highest average pension — $105,341.

The gap between average pay and average pension is widest within retirement systems with more transient employees.

The 108,814 local government employees receiving IMRF benefits in 2013 averaged pensions of $13,243. That was 34.8 percent of the system’s $38,059 average salary. However, that’s still a big change from a decade ago when the average IMRF pension was 27.9 percent of the average salary of workers paying into the system.

One lawmaker told the Daily Herald that, although the upward trend is undoubtedly real, the decreasing gap between pensions and worker salaries has slowed over recent years.

“There was a long period of time where there were rapid (pay) raises in the public sector … (and) that growth is tied to the pension formula,” said state Sen. Daniel Biss, an Evanston Democrat who helped sculpt the state’s most recent pension reform plan. “But a lot has changed and we’ve seen a dramatic slowdown, particularly in the last five years.”

Taking Stock of Where Rhode Island’s Candidates for Governor Stand On the Release of Pension Hedge Fund Records

Last month, current Rhode Island Treasurer Gina Raimondo (Democrat) denied the Providence Journal access to records relating to the state pension fund’s hedge fund investments.

The newspaper appealed, but that appeal was denied as well.

In a letter written by Raimondo at the time of the denial, she justified her actions with the following logic (the entire letter can be read at the bottom of this post):

For democracy to work, the public, often through the press, needs oversight over how government is acting on its behalf. At the same time, the government, to fulfill its obligations to the public, needs to be able to function effectively, which often requires a measure of confidentiality, particularly when contracting with private sector entities. Over the years, the law has determined how to balance these two requirements, and the actions of Treasury were consistent with that balance.

With elections only a few months away, and Raimondo in the midst of a bid for governorship of the state, Raimondo’s opponents have seized the opportunity to pounce on her decision to deny access to the hedge fund records.

Providence Mayor Angel Taveras (Democrat), who is now running for governor of the state, had this to say:

“Apparently, the treasurer is more concerned about hedge funds being able to keep their talent than taxpayers knowing how their money is being spent,” Taveras’ spokeswoman Dawn Bergantino said. “The treasurer should be looking out for our interests, not Wall Street and hedge fund billionaires.”

Allan Fung (Republican) is currently the mayor of Cranston, Rhode Island. But he’s in the running for governor of the state as well, so he put his thoughts on the table:

“There is a dramatic difference between what is required legally and what is necessary to do the right thing,” Fung said. “Current and retired state employees depend on the strength of the pension fund for their retirement security, and all Rhode Islanders face the risk of higher taxpayer contributions if these investments come up short. We all face tremendous risk and we deserve to know the basis for these investments.”

According to the latest polls, Taveras is currently up on Raimondo, garnering 33.4 percent of the vote to Raimondo’s 29 percent. Clay Pell remains a distant third with 11.5 percent of the vote.

Raimondo’s position has notably diminished since she chose to withhold the hedge fund records. Although she is drawing in the same percentage of votes, the issue may have swayed undecided voters to side with Taveras.

On the Republican side, the latest poll has Ken Block maintaining a healthy lead over rival Allan Fung.

Screen shot 2014-08-05 at 2.49.57 PM — Credit: Wikipedia

And, as promised, here is the letter that Raimondo wrote when she denied the Providence Journal access to the state pension fund’s hedge fund records.

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Photo by: By Jim Jones (Own work) via Wikimedia Commons

Memphis’ Pension Fund Is Considering Going All-In On High-Risk Strategies

For the last two years, the City of Memphis Pension Fund has been considering an overhaul in investment strategy. The strategy: re-allocating hundreds of millions of dollars from U.S. stocks and bonds into higher-risk investments. That entails increased allocations toward private equity, hedge funds, foreign stocks and bonds and real estate investments.

On August 28, the board that makes investment decisions for the fund will vote on the change in policy.

The board had already voted at its last meeting to allow the fund to double its real estate investments, from 5 percent of its portfolio to 10 percent.

Pennsylvania Weighs Risks, Rewards of Pension Obligation Bonds

Pension reform has been the talk of Pennsylvania politics these last few months, and the reasons are equally political and practical: if retirement costs keep rising, the state’s fiscal handcuffs will keep tightening—and they are already uncomfortably snug. That leads eventually to budget-cutting maneuvers, many of which are sure to be politically unpalatable.

But a recent analysis from the actuaries for the state’s Public Employee Retirement Commission presents a policy tool to save the state money. The tool: pension obligation bonds (POBs), the controversial bonds that carry big risks and big rewards for the states that issue them.

The actuarial analysis stated that the state could save $24.5 billion over the next 30 years if they issued just $9 billion in POBs. The state’s PSERS system could reduce costs by $19.8 billion with POBs, according to the analysis.

Top White House Economic Advisor Wants to Reform Tax Incentives for Retirement Income

Pension360 covered yesterday the new study examining the ways income inequality manifests itself in retirement benefits.

Gene Sperling, Director of the National Economic Council, presented his own ideas recently on the topic of inequality and retirement, and described what he labeled the “upside-down” tax incentive system that applies to retirement savings in the United States.

Sperling describes the way the U.S. tax system helps the wealthy but “shuns” low-income earners:

First, the federal government’s use of tax deductibility to encourage savings turns our progressive structure for taxing income into a regressive one: While earners in the highest income bracket get a 39.6 percent deduction for savings, the hardest-pressed workers, those in the lowest tax bracket, get only a 10 percent deduction for every dollar they manage to put away.

Second, while less than 1 percent of lower- and moderate-income Americans can put aside enough to fully “max out” their benefits on I.R.A. contributions, higher-income Americans can maximize their return on savings by sampling from a menu of tax-preferred savings options. A business owner could theoretically benefit from a 401(k), a SEP I.R.A. of up to $52,000 and a state-based 529 program that allows tax-free savings for college education.

Finally, a far larger share of upper-income Americans get matching incentives for savings from their employers. Members of Congress and the White House staff, for example, get an 80 percent match for saving 5 percent of their income. But while half of Americans earning more than $100,000 get an employer match, only 4 percent of those earning under $30,000 and less than 2 percent of those making under $20,000 get any employer match for saving.

The result of those incentives, according to Sperling: low-income workers are “triple losers” and wealthy individuals are “triple winners”.

That’s problematic, says Sperling, because low-income workers are precisely the people who should have incentives to save more for retirement.

Sperling proposes two specific policies towards that end: A flat tax credit on retirement income, and a universal 401(k) available to every worker.

Sperling:

One intermediate step would be to replace our regressive system of relying on tax deductibility with a flat tax credit that would give every American a 28 percent tax credit for savings, regardless of income. But why should we stop there? If we know that 401(k)’s with automatic payroll deductions and matching incentives work beautifully for those with access to them, why would we not institute a 401(k) for everyone?

A government-funded universal 401(k) would give lower- and moderate-income Americans a dollar-for-dollar matching credit for up to $4,000 saved annually per household. Upper-middle-class Americans could get at least a 60 percent match — doubling the incentive they get today. The match would be open to workers even if their employers were already matching, which would encourage employers to keep contributing to savings. The match would also be available through I.R.A. contributions for those who were self-employed or who wanted to keep saving even while they were temporarily not working.

As for the costs, Sperling proposes a reform to the estate tax that would raise the revenue needed to implement the 401(k) program.

CalPERS Rescinds $700 Million Investment With Private Equity Fund Headed By Doctor With No Private Equity Experience

You probably trust your doctor with your life. But with your money? Many people might balk at the notion of their doctor making their investment decisions for them.

But back in 2007, CalPERS made a big bet: a $705 million investment in a private equity fund, Health Evolution Partners Inc., specializing in health care companies.

The CEO of the fund, David Brailer, is a nationally renowned physician who had previously been the “health czar” under George W. Bush. But this was his first foray into the investment space, and he had no experience running an investment fund or making private equity investments.

Still, he reportedly promised the CalPERS board healthy returns in excess of 20 percent.

But through seven years, the fund has never managed to exceed single-digit returns. And portions of CalPERS’ investment have actually experienced negative returns.

That has led CalPERS to cut ties with the fund, according to Pensions & Investments:

CalPERS is ending its unique experiment as the sole limited partner of Health Evolution Partners Inc., a private equity firm that focuses on health-care companies.

…

CalPERS data show the HEP Growth Fund had an internal rate of return of 6.5% from its inception in mid-2009 through Dec. 31, 2013. By contrast, the $5.3 billion growth fund portion of CalPERS’ private equity portfolio returned 12.72% for the five years ended Dec. 31, the closest comparison that could be made with the data the pension fund made available.

The HEP fund of funds has had more serious performance problems. Its IRR from inception in 2007 through Dec. 31, 2013 was -5.2%, show CalPERS statistics. CalPERS also wants out of that investment, but sources say a complicated fund-of-fund structure may make that difficult.

Mr. Desrochers would not comment on HEP, telling a Pensions & Investments reporter the matter was too sensitive to discuss.

CalPERS spokesman Joe DeAnda, in an e-mail, said, “We continue to evaluate all options relating to Health Evolution Partners.”

Mr. Brailer did not return several phone calls.

CalPERS paid the fund over $18 million in fees in the fiscal year 2011-12, according to the System’s financial report.

Meanwhile, CalPERS is gearing up for another large investment partnership, to the tune of $500 million, that will focus on infrastructure investments. FTSE Global Markets reports:

The California Public Employees’ Retirement System (CalPERS) today announced a new $500m global infrastructure partnership with UBS Global Asset Management.

CalPERS, the largest public pension fund in the US, will contribute $485m to the newly formed company, while UBS will contribute $15m and act as managing member.

The partnership will operate as Golden State Matterhorn, LLC and is set to pursue infrastructure investment opportunities in the US and global developed markets.

“UBS brings extensive experience and a proven track record in global infrastructure investing that makes them a great fit for this partnership,” says Ted Eliopoulos, CalPERS Interim Chief Investment Officer. “We’re excited to work with them as we identify and acquire core assets that will provide the best risk-adjusted returns for our portfolio.”

The CalPERS Infrastructure Program seeks to provide stable, risk-adjusted returns to the total fund by investing in public and private infrastructure, primarily within the transportation, power, energy, and water sectors.

Infrastructure investments returned 22.8% during the 2013-14 fiscal year and 23.3% over the past five years, outperforming the benchmark by 17.23 and 16.6 percentage points, respectively.

CalPERS holds about $1.8 billion in infrastructure assets.

Photo by hobvias sudoneighm via Flickr CC License

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