CalPERS | Pension360

Biggs: Public Pensions Take On Too Much Risk

Andrew Biggs, former deputy commissioner of the Social Security Administration and current Resident Scholar at the American Enterprise Institute, penned a column for the Wall Street Journal this week in which he posed the thesis that public pension funds invest in too many risky assets.

To start, he compares the asset allocations of an individual versus that of CalPERS. From the column:

Many individuals follow a rough “100 minus your age” rule to determine how much risk to take with their retirement savings. A 25-year-old might put 75% of his savings in stocks or other risky assets, the remaining 25% in bonds and other safer investments. A 45-year-old would hold 55% in stocks, and a 65-year-old 35%. Individuals take this risk knowing that the end balance of their IRA or 401(k) account will vary with market returns.

Now consider the California Public Employees’ Retirement System (Calpers), the largest U.S. public plan and a trendsetter for others. The typical participant is around age 62, so a “100 minus age” rule would recommend that Calpers hold about 38% risky assets. In reality, Calpers holds about 75% of its portfolio in stocks and other risky assets, such as real estate, private equity and, until recently, hedge funds, despite offering benefits that, unlike IRAs or 401(k)s, it guarantees against market risk. Most other states are little different: Illinois holds 75% in risky assets; the Texas teachers’ plan holds 81%; the New York state and local plan 72%; Pennsylvania 82%; New Mexico 85%.

The column goes on:

Managers of government pension plans counter that they have longer investment horizons and can take greater risks. But most financial economists believe that the risks of stock investments grow, not shrink, with time. Moreover, while governments may exist forever, pensions cannot take forever to pay off their losses: New accounting rules promulgated by the Governmental Accounting Standards Board (GASB) and taking effect this year will push plans to amortize unfunded liabilities over roughly 15 years. Even without these rules, volatile pension investments translate into volatile contribution requirements that can and have destabilized government budgets.

Yet public-plan managers may see little option other than to double down on risk. In 2013 nearly half of state and local plan sponsors failed to make their full pension contribution. Moving from the 7.5% return currently assumed by Calpers to the roughly 5% yield on a 38%-62% stock-bond portfolio would increase annual contributions by around 50%—an additional $4 billion—making funding even more challenging.

But the fundamental misunderstanding afflicting practically the entire public-pension community is that taking more investment risk does not make a plan less expensive. It merely makes it less expensive today, by reducing contributions on the assumption that high investment returns will make up the difference. Risky investments shift the costs onto future generations who must make up for shortfalls if investments don’t pay off as assumed.

Read the entire column here.

Photo by dktrpepr via Flickr CC License

Kolivakis on Post-GASB New Jersey and Pension Fund Compensation

Last week, the funding ratio of New Jersey’s pension system dropped 20 points. That’s because the state began measuring funding under new GASB accounting rules, which requires using market asset values instead of actuarial ones.

This new way of measuring liabilities puts New Jersey in an even deeper hole. But as Leo Kolivakis of Pension Pulse points out, this is a hole that New Jersey dug for itself – with poor pension governance, below-median investment performance and by diverting state pension payments to other parts of the budget.

Here’s Kolivakis’ take on New Jersey’s situation, the new GASB rules and compensating pension fund staff.

__________________________

Originally published at Pension Pulse:

You can read more on GASB’s new rules for pensions here. I note the background for these changes:

On August 2, 2012, the GASB published accounting and financial reporting standards that improve the way state and local governments report their pension liabilities and expenses, resulting in a more faithful representation of the full impact of these obligations.

The guidance contained in these Statements will change how governments calculate and report the costs and obligations associated with pensions in important ways. It is designed to improve the decision-usefulness of reported pension information and to increase the transparency, consistency, and comparability of pension information across state and local governments.

For example, net pension liabilities will be reported on governments’ balance sheet, providing citizens and other users of these financial reports with a clearer picture of the size and nature of the financial obligations to current and former employees for past services rendered.

In particular, Statement 68 requires governments providing defined benefit pensions to recognize their long-term obligation for pension benefits as a liability for the first time, and to more comprehensively and comparably measure the annual costs of pension benefits.

The new GASB rules will impact all state and local pensions, not just New Jersey. This will be another important measure to determine whether U.S. public pensions are indeed on solid footing.

As for New Jersey, back in March, I commented on its pensiongate scandal and didn’t mince my words:

The article doesn’t capture the real problem at U.S. public pension plans, namely, lack of proper governance. You basically have politicians appointing political bureaucrats in charge of public pensions, paying them peanut salaries and getting monkey results. There are exceptions but this is typically how U.S. public pension funds are mismanaged.

And who benefits most from this? Of course, the Paul Singers, Dan Loebs, Steve Schwarzmans, and all the rest of the who’s who managing hedge funds and private equity funds. It’s one big alternatives party — for the big boys. Everyone is making a killing except for these public pension funds, praying for an alternatives miracle that will never happen. These alternatives managers and their sophisticated marketing are milking the public pension cow dry. They basically have a license to steal.

And why not? There are plenty of dumb institutions listening to their useless investment consultants who are more than happy to recommend the latest hot hedge fund or private equity fund to their ignorant clients. It’s a frigging joke which is why the Oracle of Omaha is 100% right when he warns us that the worst is yet to come for U.S. public pensions.

As far as New Jersey, Gov. Christie has done some good things on pension reform but a lot more needs to be done. Double-dipping pensioners are bleeding New Jersey dry. Unions can bitch all they want about rich alternatives managers meddling in their state’s politics but they must accept shared risk of their plan, which includes raising the retirement age and cuts in benefits as long as the plan is chronically underfunded. The state of New Jersey, however, should make sure it tops up its public pension plan which it neglected to do for years (the major cause of the pension deficit).

The biggest factor explaining the pension deficit in New Jersey and other states is how successive state governments failed to make their pension contributions, using the money to fund other things (no doubt in an effort to buy votes).

But there are plenty of other factors that didn’t help, like lack of sensible pension reforms, lousy investment performance and poor governance.

On this last point, Michael B. Marois of Bloomberg reports, California Pension Fund Bonus Payouts Climb 14% From Prior Year:

The $300 billion California Public Employees’ Retirement System, the largest U.S. public pension, paid $9 million in bonuses last fiscal year, up 14 percent from a year earlier as earnings exceeded benchmarks.

The fund, known as Calpers, paid $8.7 million in bonuses to investment staff in the year ended June 30, and almost $300,000 to four non-investment executives, according to data provided by the system. The rewards are based on three-year performance verses a benchmark, as well as the earnings of each asset class and individual portfolios, said spokesman Brad Pacheco.

“These awards are part of the overall compensation we provide to recruit and retain skilled investment professionals needed to ensure success of the fund,” Pacheco said.

Public-pension funds are recouping investment losses suffered during the 18-month recession that ended in June 2009, which wiped out a third of Calpers’ value. Still, the crisis left U.S. pensions short more than an estimated $915 billion needed to cover benefits promised to government workers. Taxpayers have been asked to make up the shortfall.

The biggest bonus earner was Ted Eliopoulos, the chief investment officer who recorded a $305,810 bonus last year in addition to his $412,039 base pay.

Top Job

That bonus was paid when Eliopoulos was acting chief investment officer after his predecessor Joe Dear died in February from cancer. Prior to that, Eliopoulos headed the fund’s real estate portfolio. He now earns $475,000 in base pay after he was tapped for the top investment job in September.

Eliopoulos announced in September that the fund was divesting all $4 billion it had in hedge funds, saying they were too expensive and too complicated and not worth the returns.

The pension fund earned 18.4 percent last fiscal year, 12.5 percent a year earlier and 1 percent in 2012. It estimates it need 7.5 percent annually to meet its long-term obligation to pay benefits promised to state and local government workers.

Calpers is still short $103.6 billion needed to cover those promises based on market value as of June 30, 2012, the latest figure that was available. That shortfall is up 19 percent from a year earlier.

The California fund says it must grant bonuses to help compete with the pay that employees could make if they went to work on Wall Street. Pacheco said spending money on in-house investment management saves about $100 million a year that otherwise would be paid to Wall Street in fees.

Wall Street bonuses, which rose 15 percent on average last year to $164,530 — the highest since 2007 — may climb again as a result of payments deferred from previous years, New York Comptroller Thomas DiNapoli said last month.

Four executives outside the Calpers investment office were paid a total of $295,930 in bonuses last year, the fund said. Anne Stausboll, chief executive officer, got $113,679; Chief Actuary Alan Milligan earned $75,748 and Chief Financial Officer Cheryl Eason was paid $89,703, almost double a year earlier.

Calpers paid a total of $7.9 million in bonuses in the prior fiscal year.

Compensation is part of pension governance and if you ask my expert opinion, CalPERS’ compensation is fair and accurately reflects the market, their performance and their ability to attract and retain professionals to manage billions. The only thing I would change is base it on four-year rolling returns, like they do at Canadian public pension funds.

All this hoopla on compensation at U.S. public pension funds is totally misdirected. I happen to think most U.S. public pension fund managers are grossly underpaid, just like I think some Canadian public pension fund managers are grossly overpaid (read my comment on PSP’s hefty payouts and the subsequent ones on its tricky balancing act and its FY 2014 results which were likely padded by skirting foreign taxes).

Getting compensation right is critical to the long-term health of any public pension fund but supervisors of these funds should make sure they’re paying their senior investment staff properly based on benchmarks that truly reflect the risks they’re taking. I believe in paying people for performance, not for taking dumb risks to trounce their silly benchmark (that contributed to Caisse’s ABCP disaster which the media is still covering up).

CalPERS Pays $9 Million in Bonuses in 2014; Up 14 Percent From 2013

As a result of exceeding investment return benchmarks, CalPERS paid out a total of $9 million in bonuses in fiscal year 2014. The fund paid out $7.9 million in fiscal year 2013.

More details from SF Gate:

The rewards are based on three-year performance verses a benchmark, as well as the earnings of each asset class and individual portfolios, said spokesman Brad Pacheco.

“These awards are part of the overall compensation we provide to recruit and retain skilled investment professionals needed to ensure success of the fund,” Pacheco said.

[…]

The biggest bonus earner was Ted Eliopoulos, the chief investment officer, who recorded a $305,810 bonus last year in addition to his $412,039 base pay.

That bonus was paid when Eliopoulos was acting chief investment officer after predecessor Joe Dear died in February from cancer. Prior to that, Eliopoulos headed the fund’s real estate portfolio. He now earns $475,000 in base pay after he was tapped for the top investment job in September.

[…]

Four executives outside the CalPERS investment office were paid a total of $295,930 in bonuses last year, the fund said. CEO Anne Stausboll got $113,679; Chief Actuary Alan Milligan earned $75,748 and Chief Financial Officer Cheryl Eason was paid $89,703, almost double a year earlier.

CalPERS says it pays bonuses to compete with Wall Street for talented staff.

The pension fund’s investments returned over 18 percent in FY 2014.

Paul Singer: CalPERS’ Hedge Fund Exit Was “Off-Base”

Paul Singer, a hedge fund manager, activist investor and billionaire, wrote in a recent letter to clients that CalPERS’ exit from hedge funds was “off-base”.

CalPERS said at the time that its decision to exit hedge funds was based on their “complexity, cost and the lack of ability to scale at CalPERS’ size”.

Singer responded to those criticisms, according to CNBC:

“We are certainly not in a position to be opining on the ‘asset class’ of hedge funds, or on any of the specific funds that were held or rejected by CalPERS, but we think the decision to abandon hedge funds altogether is off-base,” Singer wrote in a recent letter to clients of his $25.4 billion Elliott Management Corp.

[…]

On complexity, Singer wrote that it should be a positive.

“It is precisely complexity that provides the opportunity for certain managers to generate different patterns of returns than those available from securities, markets and styles that are accessible to anyone and everyone,” the letter said.

Singer also took issue with claims that drawbacks of hedge funds include opaqueness and high fees. From CNBC:

“We also never understood the discussions framed around full transparency. While nobody wants to invest in a black box, Elliott (and other funds) trade positions that could be harmed by public knowledge of their size, short-term direction or even their identity.”

Singer also slammed CalPERs for its complaint about the relative high cost of hedge funds.

“We at Elliott do not understand manager selection criteria based on the level of fees rather than on the result that investors could reasonably expect after fees and expenses are taken into account,” he wrote.

The broader point Singer makes is on the enduring value of hedge funds to diversify a portfolio.

“Current bond prices seem to create a modest performance comparator for some well-managed hedge funds. Moreover, stocks are priced to be consistent with bond prices, and we have a hard time envisioning double-digit annual stock index gains in the next few years,” the letter said.

“Many hedge funds may have as much trouble in the next few years as institutional investors, but investors should be looking for the prospective survivors of the next rounds of real market turmoil.”

Hedge funds have returned 2.92 percent this year, according to Preqin. Singer’s hedge fund, Elliott Associates LP, has 13.9 percent annually since 1977.

Photo by World Economic Forum via Wikimedia Commons

CalPERS Reviews Timber Allocation After Poor Performance

CalPERS was among the first pension funds to invest in timber, and now is one of the largest timber owners in the country.

But the asset class has performed poorly in recent years, and performance (2.5 percent) came in below benchmarks again in fiscal year 2013-14.

As a result, the pension fund is reviewing its commitment to timber.

From the Wall Street Journal:

The California Public Employees Retirement System is reviewing its timber holdings following a period of poor performance and questions about whether the investments are large enough to impact overall returns for the nation’s largest public pension fund.

Top investment officers and consultants to the system known by its abbreviation Calpers discussed the $2.3 billion commitment at a board meeting Monday. One consultant, Wilshire Associates managing director Andrew Junkin, hinted at the review in an Oct. 22 letter to Calpers investment committee chair Henry Jones that cited the portfolio’s “structural weaknesses” and an evaluation of its “efficacy.”

A Calpers spokesman said no decisions have been made about the future of the timber portfolio. “This process has just begun,” he said via email.

Forests valued for their timber are Calpers’ worst-performing asset since the financial crisis, with returns down .8% over the last five years and 1% over the past three years. The portfolio gained 2.5% during the 2014 fiscal year but that was well below internal goals and industry averages.

Calpers is one of the largest holders of timber in the U.S. and owns 1.46 million acres, according to Forisk Consulting LLC. But one problem identified by Mr. Junkin is that these holdings are entirely concentrated in one part of the country — the U.S. Southeast. Outside the U.S. Calpers also owns properties in Brazil, Guatemala and Australia. The forests are also struggling due to the “timing of the original purchases,” according to the letter.

Chief among the CalPERS’ concerns are that its timber allocation isn’t large enough to make an impact on its portfolio. If that sounds familiar, it’s because CalPERS used the same logic as part of the rationale for exiting hedge funds. More details from the Wall Street Journal:

The size of the program presents another challenge. The holdings represent roughly 1% of total assets at Calpers…

“It could be argued” the current allocation “is not large enough to have a significant impact,” Mr. Junkin said in his letter. At the same time, “it would be massive challenge” to increase the size of the timberland holdings “to something more impactful, say 5%.”

[…]

Any decisions about those holdings will be closely watched within the industry, said Tom Harris, a University of Georgia professor of forest business management. “When they first got involved there was a lot of ‘wow, Calpers is in, we have come of age, this is a big deal,’” said Mr. Harris, who also publishes Timber Mart-South, a not for profit publication charting timber prices for 11 Southeastern states.

CalPERS is the country’s largest pension fund.

Photo by Rick Payette via Flickr CC License

Report: CalPERS’ Strong Real Estate Returns Unlikely To Last

CalPERS has seen strong real estate returns since 2011. But a consultant for the pension fund warns in a new report that the consistent double-digit returns are unlikely to continue.

[The report, from Pension Consulting Alliance, can be read here, or at the bottom of this post.]

More details from Randy Diamond of Pensions & Investments:

The PCA report, which is contained in agenda materials for CalPERS’ Nov. 17 investment committee meeting, said sustaining those returns is unlikely because of a challenging and highly competitive investment market.

The report cites increased competition from sovereign wealth funds, high-net-worth investors and other large direct investors in real estate as among the reasons for the potentially declining results. It says persistently low interest rates are fueling the demand for income-producing assets.

In 2011, CalPERS changed the focus of its real estate program to focus on investing in income-producing properties — and away from opportunistic real estate — after suffering massive losses following the crash of the real estate market.

CalPERS spokesman Brad Pacheco said in an e-mail: “We recognize that recent high returns will be difficult to achieve in the current real estate market. Our goals now are to diversify portfolio risk and generate steady, modest gains.”

CalPERS manages $25.6 billion in real estate assets, and is planning to expand its real estate portfolio by 27 percent by 2016.

The report:

[iframe src=”<p style=” margin: 12px auto 6px auto; font-family: Helvetica,Arial,Sans-serif; font-style: normal; font-variant: normal; font-weight: normal; font-size: 14px; line-height: normal; font-size-adjust: none; font-stretch: normal; -x-system-font: none; display: block;”> <a title=”View Real Estate Report on Scribd” href=”https://www.scribd.com/doc/246505443/Real-Estate-Report” style=”text-decoration: underline;” >Real Estate Report</a></p><iframe class=”scribd_iframe_embed” src=”https://www.scribd.com/embeds/246505443/content?start_page=1&view_mode=scroll&show_recommendations=true” data-auto-height=”false” data-aspect-ratio=”undefined” scrolling=”no” id=”doc_90379″ width=”100%” height=”600″ frameborder=”0″></iframe>”]

CalPERS Commits $100 Million to San Francisco Bay Apartment Developments

CalPERS has committed $100 million to the AGI Resmark Housing Fund, which invests in three apartment development sites in the San Francisco Bay area.

More details from IPE Real Estate:

CalPERS, which declined to comment, has now allocated a total of $300m into its emerging manager program for real estate, having previously backed Sack Properties and Rubicon Point Partners in the office and data centre sectors.

[…]

With leverage at 70%, total investment could be as much as $330m.

Development properties are unlikely to be sold to other institutional owners, as was the case with Avant Housing.

Holding apartment developments and transferring them to another CalPERS account once the properties become core is a more likely option, IP Real Estate understands.

AGI Capital and the Resmark Company are serving as the respective emerging and mentoring managers for the fund.

CalPERS has previously worked with AGI in its Avant Housing venture with TMG Partners, to which it made a $100m allocation.

Resmark, which has since replaced TMG, expects three development sites to be placed into the new relationship with AGI.

An existing, 259-unit project, previously under the control of TMG and Avant Housing, has been moved to the new venture.

Ground-breaking is scheduled in the next 30 days, with the project due for completion in 19 months.

CalPERS is in the midst of a plan to increase real estate investments by 27 percent over the next few years.

HarbourVest May Be Last Party Interested in Buying CalPERS’ Stake in Under-Performing Healthcare Fund

CalPERS announced this summer it was looking to exit the Health Evolution Partners (HEP) Growth Fund, a private equity fund specializing in healthcare companies.

HEP is run by David Brailer, a world-renowned physician who had no previous private equity experience before starting the firm.

The fund promised returns of 20 percent. But its IRR as of March 31 was just 2 percent.

According to Reuters PE Hub, HarbourVest Partners is interested in buying CalPERS’ stake in the fund. From Reuters PE Hub:

HarbourVest Partners appears to be the last bidder interested in buying CalPERS’ stake in a healthcare fund run by a former Bush Administration official, according to two sources.

The California Public Employees’ Retirement System since summer has been trying to sell its stake in a growth fund managed by Health Evolution Partners (HEP). Evercore Partners is running the sales process, sources said.

Landmark Partners was also a bidder until recently, a secondary market professional said.

CalPERS is the sole limited partner in the fund and committed $505 million at its inception in 2008. So far, the GP has drawn down just over $430 million, as of March 31, according to CalPERS.

The fund’s performance has not been stellar. It produced an internal rate of return of 2 percent and a 1x multiple as of March 31, according to CalPERS.

One secondary market professional said bad blood between CalPERs and HEP likely drove away some potential buyers.

Real Desrochers, senior investment officer for CalPERS’ Private Equity Program, recommended the retirement system get out of the investment because he didn’t believe HEP would achieve its goal of a 20 percent IRR, Pensions & Investments reported in August. CalPERS investment staff earlier this year refused to allow HEP to use already-committed capital and told the firm to find a new partner or face liquidation, P&I reported.

[…]

Besides the growth fund, CalPERS committed $200 million to an HEP fund-of-funds in 2007. The sales process has not included the FoF, which had produced a negative 3 percent IRR and a 0.9x multiple as of March 31.

Read more coverage of the HEP Growth Fund here.

Photo by Hobvias Sudoneighm

Fitch: Hedge Funds Will Continue “Winning and Keeping” Public Pensions Assets

Fitch Ratings predicts that, despite several high-profile exits by pension funds this year, hedge funds will continue to count public pension funds as major investors.

The ratings agency says exits by funds like CalPERS are “not representative of broader sector trends” and says it believes hedge funds still “deliver competitive returns net of fees, while providing a degree of downside protection and uncorrelated return during periods of stress”.

From Fitch:

Recent decisions by two large US public pension plans to pull back from hedge fund investments, and the likelihood of a sixth consecutive calendar year of return averages underperforming broad equity market returns, are not expected to curb investors’ overall allocations to hedge funds, according to Fitch Ratings.

Barring an unforeseen major market decline, hedge fund assets under management (AUM) should continue on a path toward $3.0 trillion, good growth relative to 2013’s year-end level of $2.6 trillion. The rise is attributable to market appreciation and inflows outpacing redemptions. The AUM flows show significant variation by strategy, with equity-oriented funds attracting more capital in recent periods, but global macro funds falling from favor.

While hedge fund growth has certainly slowed over the past several years, the high-profile pension plan withdrawals seen over the past six weeks are not representative of broader sector trends, in our view.

The Fitch report backs its conclusions with data from several studies conducted this year:

Fitch points to analysis recently compiled by Preqin as an indicator of the progress that hedge funds have made in winning and keeping US public pension assets more broadly. The data generally shows improvements in hedge fund investment allocations by public pensions since 2010. As of June 2014, 269 public pensions in the US made allocations to hedge funds, with an average of about 8.6% of their total AUM allocated to hedge funds.

[…]

Over the past decade and a half, hedge funds have delivered steadier performance relative to the overall market during bear markets, as was seen in 2000 to 2002 and in 2008. This downside protection, however, comes at the expense of limited upside during bull markets, a trend seen in 2003, 2009 and especially 2013.

According to Hedge Fund Research, hedge fund performance averages are set to be nearer to the broad equity market measures in 2014. However, trailing 36- and 48-month annual return levels generally range around low single-digit percentages, which paint the entire sector as under delivering relative to broader equity index benchmarks.

Read the full Fitch release here.

Placement Agent in CalPERS Bribery Case Pleads Not Guilty

Alfred Villalobos, the former CalPERS board member and placement agent who allegedly bribed then-CalPERS Chief Executive Fred Buenrostro to the tune of $250,000, pleaded not guilty to bribery charges on Wednesday.

Buenrostro has already pled guilty to charges that he accepted the $250,000 bribe and falsified pension fund documents with Villalobos.