governance | Pension360

Study: Pension Funds Can Work Harder To Be Long-Term Investors

A new paper by Keith Ambachtsheer and John McLaughlin dives into the question: Do pension funds invest for the long term?

Nearly all pension funds would identify themselves long-term investors if asked. But the paper reveals that there is a gap between that sentiment and the funds’ actual investment strategies.

From ai-cio.com:

The authors […] reported a significant gap between the long-term investment aspirations of asset owners and the reality of their strategies’ implementation.

[…]

On long-term investment, the authors said there was “broad consensus” among respondents to the survey that a longer investment timescale was “a valuable activity for both society, and for their own fund.”

“However, there is a significant gap between aspiration and reality to be bridged,” Ambachtsheer and McLaughlin added.

“Here too a concerted effort—both inside pension organizations and among them—will be required to break down these barriers.”

The authors listed the barriers to long-termism: some areas of regulation, a “short-term, peer-sensitive environment”, a lack of clear investment processes and performance metrics, and difficulties in aligning interests with outsourcing providers.

The paper, which also covers governance issues, can be read here.

Photo by Santiago Medem via Flickr CC

Dallas Pension Overvalued Real Estate Investments by Millions, According to Review

An audit of the Dallas Police and Fire Pension System has revealed that the fund overvalued a number of risky real estate investments, including a vineyard in California and luxury homes in Hawaii.

The fund invests heavily in real estate but suffered $96 million in real estate losses in 2013 [Read the Pension360 coverage here].

From the Dallas Morning News:

After a year of wrangling and delay, an independent review of the $3.3 billion fund has confirmed what many suspected: accounting problems.

The review, which focused on the fund’s real estate holdings in 2013, estimates that it overvalued some properties by tens of millions of dollars.

The new appraisals and the city’s push for an audit came after The Dallas Morning News flagged problems with the fund’s accounting. The News reported in early 2013 that the fund valued many of its real estate ventures by what it had invested, rather than by appraisals or other methods. This was contrary to widely accepted standards.

“This report shows we need better governance and more transparency into our pension fund so we can address issues as they come up — not years after the damage has been done,” said Mayor Pro Tem Tennell Atkins, reading from a statement at a news conference he called Tuesday.

The specific findings:

[The review] found that $772 million in assets were at risk of being overvalued “because the valuation approaches or methods … appear to have been improperly applied and/or inconsistent with commonly accepted valuation practice.”

From this pool, Deloitte selected nine large assets that the fund had valued collectively at $585 million. The firm estimated the actual value of these assets instead to be between $507 million and $559 million.

Overvaluing assets on a fund’s books can create a falsely optimistic picture of its overall health, leaving police, firefighters and taxpayers on the hook for the future.

Fund officials, in a statement released Tuesday by their public relations firm, called the overvaluation flagged by Deloitte “financially immaterial when measured against DPFP’s entire investment portfolio.”

The Dallas fund allocated nearly 50 percent of its assets towards real estate investments as of 2012.

Photo by thinkpanama via Flickr CC License

Actuaries Call on Obama to Address Aging Issues, Retirement Security in State of the Union

The American Academy of Actuaries is urging President Obama and the U.S. Congress to tackle retirement security issues through public policy over the next two years.

That includes addressing the solvency of Social Security, improving the governance and disclosure requirements of public pension plans, and ensuring adequate retirement income for seniors who are living longer.

From the AAA:

The American Academy of Actuaries is calling on the president and the 114th Congress to commit to a focus in the next two years on addressing the needs of an aging America. A concerted national strategy on policies to support systems such as retirement security and lifetime income, health care and long-term care for the elderly, and public programs such as Social Security and Medicare, is long overdue.

[…]

As President Obama prepares to address Congress and the American people this evening, the Academy (which celebrates its own 50th anniversary this year) would point out that the state of our union is inextricably linked to the demographic transition of proportionately greater numbers of Americans entering retirement, coupled with increased longevity, or life expectancies, that will compound the fiscal challenges to both private systems and public programs in the years to come.

The AAA goes on to provide specific points that comprise a public policy “wish list”:

* Take immediate steps to address solvency concerns of key public programs like Social Security and Medicare to ensure that they are sustainable in light of changing demographics. The Academy also urges action to allow the disability trust fund to continue to pay full scheduled disability benefits during and beyond 2016.

* Evaluate and address the risk of retirement-income systems not providing expected income into old age, especially in light of increasing longevity. The Academy’s Retirement for the AGES initiative provides a framework for evaluating both private and public retirement systems, as well as public policy proposals.

* Encourage the use of lifetime-income solutions for people living longer in retirement. The Academy’s Lifetime Income initiative supports more widespread use of lifetime-income options.

* Improve the governance and disclosures regarding the measurements of the value of public-sector (state/municipal) employee pension plans. The Academy’s Public Pension Plans Actuarial E-Guide provides information on the nature of the risks and the complex issues surrounding these plans.

* Explore solutions to provide for affordable long-term care financing, and address caregiver needs and concerns through public and/or private programs.

* Address the impact of delayed retirement, either voluntary or through future retirement age changes, on benefit programs, as well as the needs it may create with increased demand for early retirement hardship considerations and disability income programs.

Read the full release here.

Private Equity Firm Allows Investors to Hire Advisor to Monitor Governance, Review Financial Records

A New York Times report over the weekend posed the question: is private equity becoming less private?

One private equity firm, Freeman Spogli & Company, recently revealed that it allowed investors in one of its funds to hire an outside adviser to “monitor the fund’s practices”.

Investors in the fund include several of the country’s largest pension funds, including the New York State Common Retirement Fund.

From the New York Times:

Is private equity about to get a little less private?

Perhaps so, judging by the decision of a venerable private equity firm to allow investors in one of its funds to hire an independent adviser to monitor the fund’s practices. Beyond reviewing the books and financial records at the fund, the outside adviser would also be permitted to scrutinize the fund’s governance practices for conflicts of interest, the firm said.

This shift in practice, which has not been previously reported, was disclosed to investors in June by Freeman Spogli & Company, a $4 billion private equity firm created more than 30 years ago, in a letter laced with legal jargon that obscured the import of the decision.

The new policy applied to the firm’s newest fund: FS Equity Partners VII, which opened for investment this year and has closed with $1.3 billion in committed funds. Investors in that fund include pension funds and public investments, such as the Kansas Public Employees Retirement System, the New Mexico State Investment Council and the New York State Common Retirement Fund.

[…]

Allowing the appointment of a monitor is no small matter. Giving an outsider routine access to internal fund operations is practically unknown in the $3.5 trillion private equity industry, where powerful firms operate in near secrecy and hold so much sway that many investors say they feel fortunate to be allowed to put money into the funds. The independent adviser will report to the fund’s investors.

Karl Olson is a partner at Ram, Olson, Cereghino & Kopczynski who has sued the California Public Employees’ Retirement System, known as Calpers, to force it to disclose fees paid to hedge fund, venture capital and private equity managers. He said he had never seen a provision allowing an independent monitor at a private equity fund.

“It does seem like a step in the right direction because too often the limited partners are unduly passive,” he said, referring to investors. “They should feel they are in the driver’s seat and that they have an obligation to drive a hard bargain with the funds.”Phone calls seeking comment at both the New York and Los Angeles offices of Freeman Spogli were not returned.

The NY Times report speculates that the firm may have allowed the hiring of the independent adviser after the SEC began asking questions about “several of the firm’s practices”.

Yves Smith on AOI’s Hedge Fund Principles

This week, the Alignment of Interests Association (AOI) released a set of proposed changes in the way hedge funds do business with their investors, such as pension funds.

AOI, a group to which many pension funds belong, said that hedge funds should only charge performance fees when returns beat benchmarks, and that fee structures should better link fees to long-term performance.

The proposals can be read here.

Yves Smith wrote a post at Naked Capitalism on Thursday weighing in on some of the proposals. The post can be read below.

_______________________

By Yves Smith, originally published at Naked Capitalism

Admittedly, some of [AOI’s] ideas sound promising, such as requiring funds to disclose if they have in-house pools not open to outside investors, or if they are subject to non-routine regulatory inquiries. But their key proposals are around fees. As readers probably know from private equity, the devil for this sort of thing lies in the details.

One of this group’s Big Ideas is requiring funds to meet benchmarks before profit shares are paid out, meaning the famed prototypical 20% upside fees. And they do sensibly want those fees to be based on annual rather than monthly or quarterly performance (with more frequent fees, an investor could have a lot of performance fees paid out in the good periods more than offset by underperformance or losses in the bad ones, and not see a settling up until he exited the fund or it was wound up. Longer performance periods reduce the odds of overpayment for blips of impressive results). But private equity funds have long had clawbacks. Yet as we’ve discussed at length, those clawbacks are virtually never paid out in practice. One big reason is the way the clawbacks intersect with tax provisions that serve to vitiate the clawback. It would be perfectly reasonable for hedge funds to ask for provisions similar to those used by private equity funds, with those clever tax attorneys modifying them to the degree possible to make them work just as well, from the perspective of the hedgies, as they do for private equity funds.

Hedge fund investors also want management fees to scale more with the size of fund. Again, that exists now to some degree in private equity funds, with megafunds charging much lower management fees. But it isn’t clear how much the hedge funds investors will gain. Bloomberg reports that the average management fee in the second quarter of this year was 1.5% of assets. That’s lower than typical private equity fees, which according to Eileen Appelbaum’s and Rosemary Batt’s Private Equity at Work still averaged 2%, and for funds over $1 billion, 1.71%. And of course, the fact that hedge fund agreements are treated as confidential, just as private equity agreements are, impedes fee comparisons and tougher bargaining. If this group really wanted to drive a tougher bargain, they’d insist on having the contracts be transparent. That proposal is notably absent.

In keeping, the AOI also calls for better governance. We’ve seen how well that works from private equity land. “Governance” in private equity consists of an advisory board which is chosen by the general partner from among its limited partners. You can bet that the general partners choose the most loyal and clueless investors. The only way one might take oversight arrangements seriously is if these funds had far more independent boards, as is the case with mutual funds.

So while I would be delighted to be proven wrong, history says that there isn’t much reason to expect this effort to get tougher with hedge funds to live up to its billing. And with new investment dollars continuing to pour in despite mediocre performance (assets under management rose 13% in the last year, with roughly half the increase coming from new contributions/a>. As long as investors are putting more money into hedge funds despite dubious performance, there isn’t sufficient negotiating leverage to push for more than token reforms.

Photo by c_ambler via Flickr CC License

Report: U.S. Pension System Ranks 13th Among World’s Largest Economies; Faces “Major Shortcomings”

Mercer has released its 2014 Melbourne Mercer Global Pension Index report, which ranks the pension systems of the world’s 25 most advanced economies.

The report grades pension systems on coverage, governance, investment performance, tax support and plan design, among other criteria.

The United States’ pension system ranked 13^th overall, which equates to a “C” grade.

The report included a brief summary of how the U.S. could improve their ranking:

The overall index value for the American system could be increased by:

– raising the minimum pension for low-income pensioners

– adjusting the level of mandatory contributions to increase the net replacement for median-income earners

– improving the vesting of benefits for all plan members and maintaining the real value of retained benefits through to retirement

– reducing pre-retirement leakage by further limiting the access to funds before retirement

– introducing a requirement that part of the retirement benefit must be taken as an income stream.

Here are the overall rankings:

Read the full report here.