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Pennsylvania Auditor General Urges State Pensions to Pull Back From Hedge Funds, “Dramatically” Reduce Risk

Pennsylvania Auditor General Eugene DePasquale has been vocal in the past about his desire for the state’s pension systems to decrease their allocations to hedge funds.

He doubled-down and expanded on that stance Thursday, saying the state-level pension funds’ risk appetite needs to be “dramatically pulled back”.

He also called on the pension systems to reduce investment fees and change funding models.

DePasquale made these announcements after examining the pension system of Montgomery County, which uses a low-cost investment approach that includes investing heavily in passive index funds. The approach represents a stark contrast with the state-level pension systems.

Montgomery County Commissioners Josh Shapiro explains how his county’s pension fund operates:

Historically the county invested money from the pension fund with Wall Street money managers, Shapiro explained.

“What we found was that they just were simply not getting the returns our retirees needed,” Shapiro said. “We, as a pension board, worked hard at looking at different models of funding our pension system that would work better than what we historically had.”

Shapiro said the county began investing 90 percent of the fund in Vanguard two years ago and has since has seen a return of 16.23 percent while saving more than over $1 million in fees.

“We knew we were creating a template that could be used by other municipalities and maybe even by the state,” Castor said. “The obligation that we have to our retirees is to make sure the funding is there today, tomorrow and 40 years from now. The health of that plan is part of the covenant we have with the people who do the work here at Montgomery County and at the state.”

DePasquale then suggested that the state-level pension systems could learn from the successes of Montgomery County, according to the Times-Herald:

DePasquale said the state needs to emulate Montgomery County, where the pension funds are invested in a stock index fund.

“Before you get there we have to reduce our exposure into the hedge fund area,” he said.

According to DePasquale, the public school retirement system has 10 percent of its investments in hedge funds, while the state employee retirement system has approximately 6 percent of investments in hedge funds.

“That risk needs to be dramatically pulled back,” DePasquale said.

A final point DePasquale made about the state pension system is that the fees going to private equity and hedge fund managers need to be reduced.

“Pennsylvania is a large state,” he said. “We have a huge leverage tool in the amount of money that we have in our pension system. For some reason our Public School Employment Retirement System and our State Employment Retirement System refuses to use that leverage to negotiate lower fees.”

This isn’t the first time DePasquale has asked the state’s pension funds to pull back from hedge funds.

That led pension officials to defend their hedge fund investments. The chairman of the Pennsylvania’s State Employees Retirement System board of trustees said this in September:

Industry experts generally agree that while hedge funds are not for every pension system, the unique needs of each system must shape their individual asset allocation and strategic investment plans. Therefore, the actions taken by one system may not be appropriate for all systems. Investors need to consider many factors including their assets, liabilities, funding history, cash flow needs, and risk profile.

[…]

To date, the strategy has been working. As of June 30, 2014, our diversifying assets portfolio, or hedge funds, made up approximately 6.2 percent of the total $28 billion fund, or approximately $1.7 billion. In 2013, that portfolio earned 11.2 percent or $197 million, after deducting fees of $14.8 million, while dampening the volatility of the fund. That performance helped the total fund earn 13.6 percent net of fees in 2013, adding more than $1.6 billion to the fund.

Photo by Paul Weaver via Flickr CC License

Survey: Institutional Investors Often Driven Towards Short-Term Thinking

Previous surveys have shown that pension funds almost universally consider themselves long-term investors. But their investment decisions, by their own admittance, can often reflect short-term thinking.

A new survey sheds some light on the factors and pressures that cause pension funds to break away from long-term thinking.

Summarized by Chief Investment Officer:

Accounting demands, valuation models, and modern portfolio theory are driving institutional investors towards short-termism, Hermes Investment Management has claimed.

After conducting a survey of more than 100 European investors, the fund manager reported that 44% said external pressures were forcing them away from views in line with their long-term liabilities.

“The short-term factors driving the management of pension schemes require detailed attention,” said Saker Nusseibeh, CEO of Hermes Investment Management. “Schemes need to have the freedom to act and focus on longer term considerations to best serve their end beneficiaries, savers.”

Hermes is owned by the UK’s largest pension, the BT Pension Scheme.

One of the major headaches for investors, the survey found, was quarterly results, with 44% demanding longer-term reporting. Pension accounting measures and triennial valuations were equally admonished by respondents.

This short-term thinking is also taking investors’ eyes away from their roles as good shareholders. Some 37% told the survey they thought focus on short-term investment performance acted to disconnect them from “their responsibilities as owners of actual companies”.

Additional questions were asked about innovation in the asset management industry. Some 42% said they wanted greater innovation around outcome-focussed investing, while 32% wanted better ways to reduce volatility.

More than half—56%—said they wanted innovation around the disclosure of costs.

The survey was conducted with 100 institutional investors from across Europe.

Photo by Santiago Medem via Flickr CC

Canada Pension Chief Talks About “One of the Best Investments We’ve Ever Made”: Investing in Alibaba in 2011

The chief executive of the Canada Pension Plan Investment Board (CPPIB) talked with the Financial Post on Thursday about the Board’s investment in Alibaba in 2011.

At the time, Alibaba was an unknown tech company in China. A few years later, the company’s initial public offering was the largest in history.

From the Financial Post:

[Wiseman] said the reason the Canadian pension fund manager was able to make a “very sizeable investment” in what was then “an obscure Internet company” in a city in China few had heard of is because executives had opened an office in Hong Kong back in 2008.

“That investment story which everybody is touting as one of the best investments we’ve ever made, it didn’t happen overnight. That investment started in many respects almost seven year ago,” Mr. Wiseman said.

“It started with a view towards that market, a view that we need to build capabilities in the region, that we need to deepen our understanding of the region, and that we had a long-term view around the Chinese consumer, the importance of the Chinese consumer.”

Mr. Wiseman said the route to the Alibaba investment, which is worth “substantially more” than the fund’s cost base thanks in part to a large investment in the successful IPO last month, illustrates the long-term strategy and the “on the ground” investing style.

“We didn’t get brilliant in four weeks, right? … We had people on the ground in Hangzhou [the city in China where Alibaba is based] before people knew where Hangzhou was,” he said.

“We were there soon after opening our office in Hong Kong, developing those relationships with people who speak the language and who understand the market… To me, this is exactly what we’re trying to do as an organization.”

After the initial investment in 2011, CPPIB increased its stake the following year and then again through the IPO, Mr. Wiseman said.

The CPPIB has a total of $314.5 invested in Alibaba.

Photo by Charles Chan via Flickr CC License

South Carolina Pension Seeks Smaller Hedge Fund Managers

The South Carolina Public Employee Benefit Authority (PEBA) allocates a large portion of its assets towards hedge funds – 17 percent, as of June 30.

But PEBA is looking for a change. It isn’t considering moving away from hedge funds, but it is looking at different kinds of hedge funds. Namely: smaller ones.

From Bloomberg Briefs:

South Carolina’s pension is interested in allocating to smaller hedge fund managers to enhance diversification and capture increased returns as it reduces holdings in larger funds, according to state treasurer Curtis Loftis.

The $30 billion pension had 14 investments in “strategic partnership funds” of $1 billion or more at the start of this year, of which it has “unwound about half,” Loftis said in a speech at the Alternative Asset Summit in Las Vegas last month. It is “very interested in emerging managers” to help with this “fear of non-diversification, and to enhance returns” he said in the Oct. 28 speech. The pension has already made “several or so investments of $50 million or less the last few of months,” he said. This includes a commitment of $25 million to $50 million last month to a small manager that Loftis declined to identify.

“I love alternative investments. I love Wall Street. I don’t mind paying fees,” Loftis said in 2013. “But I want returns.” The pension last year had investment fees and expenses of 1.59 percent of assets, compared to a national average of 0.57 percent, according to a presentation on its website.

[…]

The state treasurer suggested emerging hedge funds to “come show up” at public meetings of public pension plans, including the South Carolina Investment Commission. “If I were an emerging manager and I wanted to understand how public pension plans work, I would attend the meetings, shake hands and pass out cards.”

The move is interesting because there is data out there suggesting pension funds can get the best returns by investing with newer, smaller hedge funds.

Dr. Linus Wilson writes:

Most institutions and their consultants implicitly or explicitly limit their manager selection criteria to hedge funds with a multi-year track record (three years or more) and assets under management in excess of $250 million. The AUM screen is probably higher; $1 billion or more. Unfortunately, all the evidence shows that choosing hedge funds with long track records and big AUM is exactly the way to be rewarded sub-par returns.

A recent study by eVestment found that the best absolute and risk-adjusted returns came from young (10 to 23 months of performance) and small (AUM of less than $250 million) hedge funds. My anecdotal evidence is consistent with this fact. My young and small fund, Oxriver Captial, organized under the new JOBS Act regulations, is outperforming the bigger more established funds.

Dr. Wilson believes pension funds are ignoring data that suggests newer, smaller managers perform better than the older, larger hedge funds that pension funds typically prefer

Read Dr. Wilson’s entire piece here.

Survey: 81 Percent of Pension Funds Looking to Bring More Investment Management In-House

CalSTRS recently announced its plans to eventually manage 60 percent of its assets internally. According to a recent survey, a majority of pension funds are beginning to think the same way.

A survey by State Street released this week found that 81 percent of pension funds are planning to bring more investment management duties in-house in the near future.

From BenefitsPro:

81 percent of funds are exploring bringing more management responsibilities in-house over the next three years.

Cost concerns are driving the trend, as 29 percent of funds said it is becoming more difficult to justify the fees paid to outside managers.

“Pension funds’ desire to deliver strong investment returns to their participants coupled with improved oversight and governance is leading to a need for more in-house accountability for asset and risk management,” said Martin Sullivan, head of asset owner sector solutions for North America.

The State Street data doesn’t suggest that outside management will become obsolete, but rather that pension funds are becoming more judicious about how they select and manage outside relationships.

The largest funds have the capacity to handle multi-asset management in-house, but they are in the minority, Sullivan noted.

“The majority of pension funds will need to make a choice about where to be a specialist and when a sub-contractor is needed,” he said.

The survey examined responses from 134 defined benefit and defined contribution funds around the globe.

The survey also found funds are willing to take on more risk:

While pensions funds re-examine their relationships with outside managers, 77 percent are also reporting a need to increase their risk appetite to boost lackluster returns.

That means a greater push into alternatives, as equities and fixed-income “may look pricey.”

“Pension funds are finding that a small allocation to alternatives is not sufficient to generate the required growth. This is forcing many of them to place bigger bets on alternatives,” according to the report.

The full report, called “Pension Funds DIY: A Hands-On Future for Asset Owners,” can be found here.

San Diego Pension Close to Firing Outsourced CIO, Bringing Investment Management In-House

The San Diego County Employees Retirement Association (SDCERA) is on the verge of firing its controversial outsourced CIO, Lee Partridge of Salient Partners.

Board members held a mock vote on the issue, and the firing was “approved” 7-0.

If Salient Partners is indeed fired, the SDCERA would move its investment management in-house.

More on the situation from the Union-Tribune:

The county retirement board has made an informal decision to end its five-year experiment with a Texas portfolio strategist and return oversight of the $10 billion pension fund to an in-house expert.

The vote came late Thursday toward the close of another marathon meeting of the San Diego County Employees Retirement Association board, which has been racked with discord in recent months over its leverage-heavy investment policy.

An hour into a late-afternoon discussion on governance models, Trustee Dick Vortmann suggested their time might be better spent if they knew whether the board majority still supported using an outsourced chief investment officer.

“Can we take a straw poll right now?” he asked. “For Christ’s sake, if it isn’t a close debate, why are we debating?”

Minutes later, all seven trustees in attendance raised their hand to show they are ready to hire an internal investment officer to manage the fund — a function that has been served by Salient Partners of Houston.

The 7-0 vote isn’t as clear cut as it sounds.

The vote wasn’t official – and it didn’t include all the trustees. Two trustees had left the meeting before the vote was held. At least one of those trustees, David Myers, is likely to vote to retain Salient Partners. From the Union-Tribune:

The nonbinding vote excluded board members David Myers, who was absent, and Mark Oemcke, who left the meeting earlier in the day. Myers has been a staunch supporter of Salient and its main representative in San Diego, Lee Partridge. Oemcke has not.

Three of the seven board members to vote — Vortmann, Kristina Maxwell and E.F. “Skip” Murphy — said they were raising “half a hand” to reflect concern over finding the right candidate for the job.

“It’s qualified on the assumption that we can find the requisite skills to match our desired level of sophistication on our investment philosophy,” Vortmann said.

No one from Salient was at the meeting.

While not yet formalized, the decision to abandon the outsourced CIO model prompted trustees to begin the process of recruiting an in-house investment expert.

They plan to hire an executive search firm in two weeks, when the board convenes a special two-day retreat. Installing a chief investment officer is expected to take between four and six months.

SDCERA pays Salient $10 million a year to perform CIO duties.

A consultant told the SDCERA board that they could likely hire a new, qualified CIO for less than $250,000.

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.

International Organization Raises Questions About Governance, Oversight of UN Pension Fund

Last week, the Coordinating Committee of International Staff Unions and Associations (CCISUA) raised concerns to the UN General Assembly about governance problems at the UN pension fund.

The remarks were delivered by Ian Richards, President of CCISUA, a group composed of UN system staff unions and associations.

Concerns included the weakening of the methods by which pension staff can report fraud and abuses, the possible harassment of whistleblowers and other managerial issues.

The remarks from Ian Richards:

Let me end with a common system issue of great concern to us, the management of the pension fund, an item you are also considering today.

We welcome the decision of the fund’s board that it should continue to be administered by the UN Secretariat, ensuring that the necessary management controls can be maintained.

But we are concerned that the management team at the Fund is actively seeking waivers to four important elements of the staff regulations. If approved, we foresee reduced opportunities for qualified pensions experts in your countries to work at the Fund and a weakened ability of OHRM to check abuses of authority.

Firstly, management has requested exemption from the UN mobility policy as its functions are specialized. Yet, as you are aware, having passed the mobility policy in April, mobility already exempts specialized posts; this matter is moot.

Secondly, management wants discretionary authority to keep some staff beyond retirement, citing an IT project. Such discretion will remove incentives for workforce and succession planning and does not make strategic sense. The Fund’s new IT system will need to be implemented by staff who can stay on for years to come in order to manage and maintain it.

Thirdly, management wants to promote certain colleagues from the G to P categories without passing through the exam, an issue on which you may well have an opinion.

Finally, management has asked for the right to laterally assign staff in contravention of your own instructions, reiterated on many occasions, that all vacancies be advertised externally.

Distinguished delegates, all this is taking place in a UN department whose management recently issued a directive forbidding staff from reporting fraud to OIOS. We have also received reports of alleged threats against suspected whistleblowers. With $51 billion at stake, this is alarming. As Member States, ultimately responsible for the fund’s finances. I therefore trust that you will seriously examine these risks to the Fund.

The full remarks, which include a discussion of retirement age, can be read here.

They can also be seen starting at around the 31:30 mark of the following video:

Public Pensions Outperformed Endowments in Fiscal Year 2014

For the second year in a row, U.S. public pension investment returns outpaced endowment funds.

Endowment funds on the whole returned 15.8 percent, while public pension portfolios returned 16.86 percent.

From Chief Investment Officer:

US university endowments returned an average 15.8% in the fiscal year ending June 30—more than 100 basis point less than the typical public pension fund, two studies have shown.

Public pensions rode their large equities allocations (averaging 61%) to 16.86% gains, Wilshire Associates reported in August. Funds larger than $1 billion did even better, returning 17.44% for the fiscal year.

Endowment portfolios, in contrast, held an average 30% of the best-in-class performing asset, according to preliminary data from the annual NACUBO-Commonfund study. For the 129 institutions evaluated, domestic equities generated 22.6% returns while international stocks gained 19.6%.

“Smaller endowments, which typically have the largest allocations to traditional asset classes, benefited from the strong performance of liquid domestic and international equities beginning in 2009,” said Commonfund Institute Executive Director John Griswold.

“But,” he added, “the greater diversification practiced by the largest endowments and their emphasis on a variety of sources of return, both public and private, tends to result in higher long-term investment performance.”

[…]

A number of the nation’s most high profile, elite universities have, in recent weeks, revealed FY2014 performances far in excess of the average large endowment’s 16.8% gain.

Yale University earned 20.2%, Princeton 19.6%, MIT 19.2%, and Columbia returned 17.5% on its $9.2 billion portfolio.

But the largest, most-watched endowment of all once again failed to enter the winner’s circle. Harvard University disclosed its sub-par 15.4% returns for FY2014 just hours before announcing the replacement for outgoing CEO Jane Mendillo. Managing Director and Head of Public Markets Stephen Blyth is set take over the $36.4 billion fund on January 1, 2015.

To see a breakdown of endowment funds’ returns by asset class, click here.

San Francisco Pension To Vote Again On Hedge Funds

The San Francisco Employees’ Retirement System is once again weighing whether to begin investing in hedge funds.

Last Spring, the fund formulated a plan to invest up to 15 percent of its assets, or $3 billion, in hedge funds. But the vote has been tabled three times since then.

This week, the fund will vote again on the issue.

From SFGate.com:

The board of the San Francisco Employees’ Retirement System is scheduled to vote Wednesday on a controversial proposal to invest $3 billion — 15 percent of its assets — in hedge funds. The system, which manages $20 billion in pension money on behalf of about 50,000 active and former city employees, has no hedge funds today.

[…]

A 15 percent allocation would definitely have an impact on the San Francisco pension fund. William Coaker Jr., who joined the system Jan. 30 as chief investment officer, wants to put 15 percent of its assets in hedge funds as a way to protect against a market correction. But some board members and pensioners see them as too expensive and risky.

[…]

Earlier this year Coaker and his staff, along with outside consultant Leslie Kautz of Angeles Investment Advisors, recommended investing 15 percent of the system’s assets in hedge funds as part of a realignment of its portfolio. The goal was to “reduce volatility in investment returns, improve performance in down markets, enhance diversification of our plan assets, increase the flexibility of the investment strategy, and to increase alpha (excess returns),” according to minutes of the June 18 meeting. Coaker did not return phone calls.

A vote on the measure was scheduled for October but shortly before the meeting, board President Victor Makras learned that Kautz’ firm has a fund of hedge funds registered in the Cayman Islands. “That was a material fact,” Makras said. “I continued the item and instructed the consultant to disclose that to my satisfaction.”

If the fund does vote to invest in hedge funds, there would be the following allocation changes, according to SFGate:

U.S. and foreign stocks would drop to 35 percent from 47 percent of assets. Bonds and other fixed-income would fall to 15 percent from 25 percent. Real estate would rise to 17 percent from 12 percent. Private equity would rise to 18 percent from 16 percent. And hedge funds would go to 15 percent from zero.

The San Francisco Employees’ Retirement System manages $20 billion in assets.

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