In this issue
CIO salary conundrum
Jeff Scott – innovation at Alaska’s $33bn crown jewel
Fight night – Buffett versus Gross
Gillian Wee, writing for Bloomberg Markets Magazine, noted that the position of chief investment officer in U.S. college endowments has experienced increasing turnover due to low pay, uneven investment performance and increased expectations. I couldn’t agree with her more, since she quoted me generously.
See: “Help Wanted On Campus:”
Comings and Goings:
Bruce Malott: An Embarrassing Exit in Albuquerque:
On the first of September, Bruce Malott, board chair of New Mexico’s teachers’ pension Educational Retirement Board, with $8.5 billion AUM, arrived for an interview with the Albuquerque Journal. He was flanked by four lawyers, a private investigator and a public relations rep.
He admitted that he had accepted a $350 thousand personal loan from the father of a third-party marketer who had done business with the pension, earning millions in finder’s fees thereby. Then he resigned from the board a few hours later.
See: Albuquerque Journal: “ERB Chief Resigns, Admits Correra Loan”
Mr. Malott was already under fire before the loan was revealed. In fact, there is a fascinating but convoluted back-story involving an allegedly whistle-blowing chief investment officer, a definitely toxic CDO, and even presidential politics. And there are dueling narratives about what happened. Here are some of the high points. We refer you to the links for the gory details.
Frank C. Foy, ERB’s former chief investment officer, filed suit against Mr. Malott and sundry others in 2009 under a state whistle-blower statute. He claimed that there was political influence on the board and investment staff to purchase a piece of a collateralized debt obligation in 2006. Vanderbilt Capital, the Chicago firm which hatched the CDO was a contributor to the failed presidential campaign of New Mexico Governor Bill Richardson. Mr. Malott was a former campaign treasurer for Governor Richardson and was appointed to the ERB chairmanship by the governor. Mr. Foy drew the darkest inferences from these relationships.
See: State of New Mexico ex rel. Frank C. Foy vs. Vanderbilt Capital Partners, Bruce Malott, etc, etc
After the CDO deal, Mr. Foy was demoted and eventually left the ERB. He claims it was retaliation for resisting the alleged political pressure and trying to stop the CDO investment. Others say the demotion resulted from a charge of sexual harassment.
Like most of the CDOs backed by U.S. mortgages in the previous decade, the Vanderbilt item did, indeed, collapse. ERB took a $40 million loss and their New Mexico sister fund SIC (State Investment Council) lost another $50 million on the same tranche of the same investment.
Most of Mr. Foy’s suit was thrown out by a judge on technical grounds this spring, so his claims were never adjudicated. It’s too bad, because it would have been interesting to hear some of these individuals deposed under oath. But he has brought other actions against which Mr. Malott was still defending himself when he was forced to resign.
Where the truth lies in all this we can’t say, but we’ve looked at contemporaneous minutes from the ERB investment committee from May 12, 2006, when the CDO was discussed. Vanderbilt CEO Patrick Livney was there in person to pitch his product, along with Mr. Malott, Mr. Foy, the fund’s principal advisor, and other key players.
Mr. Livney, sounding rather like a used-car salesman on a slow day, encouraged the board to act quickly. If they signed the deal within three days, he said, they could avail themselves of a special “friends and family” rate. He also pointed out that the default rate on Vanderbilt CDOs since 1996 had been zero. Really.
Then, according the transcript: “Mr. Foy said the investment division recommends to invest [sic] between a minimum of $20 million and a maximum of $40 million in this vehicle.”
It doesn’t sound to us like the CIO put up much of a fight when it might have actually made a difference.
As to the tone of their deliberations, we note that one of the investment committee members, a Mr. Brown, was heard to ask: “What exactly is a CDO?” No kidding.
See: “Minutes – Investment Committee Meeting – May 12, 2006”
In a special meeting of the full board called by Mr. Malott on the same day (apparently gaveled right after the investment committee meeting), the deal was accepted by a 4-to-2 majority. This speedy approval certainly nailed down Mr. Livney’s “friends and family” rate.
One of the two dissenters, Dr. Pauline Turner, said in the minutes that she thought the board was making “what appeared to be a hasty decision” because its members hadn’t been educated on the type of investment they were about to make and didn’t have policies and procedures in place to deal with such investments.
It occurs to us that a few thousand Pauline Turners, strategically distributed, could have stopped the sub-prime mortgage bubble in its tracks.
See: ERB Board Minutes – May 12, 2006
All of the dramatis personae are now gone from ERB, including the skeptical Dr. Turner, who resigned after fourteen years due to health problems.
For whatever reason, Mr. Foy was demoted to Deputy CIO and then left. He was replaced by Robert Jacksha, who had been interim State Investment Officer (i.e., CIO) at their sister fund, the New Mexico SIC.
Robert Smith: Filling a gap in New Mexico:
We noted above that Robert Jacksha, who had held the post of New Mexico State Investment Officer at the State Investment Council, moved over to the New Mexico teachers’ pension (Educational Retirement Board) in March, replacing the departed Frank C. Foy.
Last week it was announced that New Mexico had hired Robert “Vince” Smith to fill the vacant SIC position. Mr. Smith, chief investment officer of the Kansas PERS pension since 2006, will be paid $212,500 in his new post. The New Mexico SIC has assets of about $13 billion.
Mr. Smith managed to leave Topeka on a high note. On September 1, KPERS announced a 14.9 percent gain for FY 2010, a big turnaround from the previous year’s 19.6 percent loss. The fund beat its benchmarks for all asset classes except alternatives.
Still, Kansas remains one of the two or three most under-funded public pensions in the country. It had an actuarial funding ratio of just 59% in FY 2009. And it barely moved the needle up to 60% for 2010.
The Center for Applied Economics at the University of Kansas School of Business issued a report in September 2009 saying that KPERS is “experiencing a funding crisis” and is “bankrupt under current operating assumptions.” They conclude that “Elected officials charged with oversight of the state pension system failed to fulfill their charge.”
On the other hand, State Senator Steve Morris, chair of the state’s joint committee on pensions, recently said, “We are not in a crisis, but if we don’t take action in the near future, we could be.
They can’t both be right.
New Mexico’s SIC is in relatively good shape financially, but, as we noted above, both the ERB and SIC funds continue to be embroiled in questions about possible pay-for-play issues. As an outsider, Mr. Smith at least arrives unstained by the local goings-on.
Charles W. Grant: Craving Family-time in Richmond
On Monday August 30, Virginia Retirement System CIO Charles Grant announced pretty good results for his $48 billion fund’s latest fiscal year: a 14.1% return on investment, up from a negative 21.1% in FY2009. That’s about average among state pensions which have reported so far, but short of VRS’ own 1-year benchmark of 15.3%.
Then, on the following day, VRS announced Mr. Grant’s forthcoming departure. He’ll be gone in August, 2011, at the end of his current contract. Mr. Grant himself said the move was “…due purely to family reasons and the desire to dedicate more time to them.” A search for his replacement commences immediately.
A VRS spokesperson told Pensions & Investments that there would be no further comment on the reasons for his departure, and Mr. Grant did not return their phone calls.
A “family-time” resignation tends to lift eyebrows, but that’s their story and they’re sticking to it.
Mr. Grant has been with VRS since 1995, serving successively as managing director of fixed income, and then as Deputy CIO, getting the top job in 2005.
We note, more in sorrow than in anger, that the VRS board has decided to run the search out of their own offices rather hire a reliable and cost-effective professional. Well, best of luck to them. As the Romans said: Empta dolore docet experientia.
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Whoever finally takes the position will have some pressing issues to deal with. VRS recently lowered its projected return figure from 7.5 percent to 7.0 percent. This will require a significant jump in employer contributions. And that’s on top of $520 million that should have been kicked in by the state this year, but wasn’t. The governor chose to withhold that amount to balance the budget.
Seventy percent of the pension’s revenues come from investment earnings, so the pressure will by on Mr. Grant for another twelve months before he gets much of that family-time.
Observations: The Exodus from Indiana
We could not help but notice the flight of pension CIOs from Indiana over the summer.
First, Shawn Wischmeier, CIO of the PERF fund, departed in June, fetching up in North Carolina. In his new post he will get $320,000, and the potential for annual bonuses of up to 15%, more than double his previous $126,000.
Then, in July, Timothy Walsh, CIO of the smaller TRF fund, said adios to Indianapolis and became director and CIO of the New Jersey pension system for a salary of $185,000.
I spoke to some people close to the situation and tried to puzzle it out. It seems that the Indiana legislature, pushed by Governor Mitch Daniels, crafted a partial merger of the two major state pensions back in March. The two plans are still legally distinct, but now report to a single board and a single executive director.
Spooked by the portfolio losses in 2008, and the specter of rising contributions required from public employers, the pols thought they could save money by merging investment activities. There would be some small savings in administrative expenses and, they hoped, outside managers would give them better deals and better returns if they could do business as a single $22 billion fund.
Obviously, they now had a spare executive director and an extra CIO. The new board decided to keep Steve Russo, director of TRF and make him director of the merged entity. But what about the new “merged” CIO slot?
Now the story becomes slightly murky. It appears that Mr. Wischmeier thought he was not in the running for the job, while Mr. Walsh, on the other hand, had reason to believe that he would be a strong candidate. Mr. Wischmeier was doing a good job at PERF, but Mr. Walsh, CIO of the smaller TRF, had a heavier resume and more experience. So Mr. Wischmeier accepted a very good offer from North Carolina, and Mr. Walsh awaited developments.
Then it was decided that, instead of simply putting Mr. Walsh in the new, super-sized job, Mr. Russo and the new board would undertake a national search. Mr. Walsh was not pleased. When he received an offer from New Jersey, he was out the door.
The final act unfolded two weeks ago when David Cooper, formerly Mr. Wischmeier’s Deputy CIO at PERF, was tapped by the national search and got the new “merged” CIO post.
It’s not our job to second-guess the board, the search committee, or Mr. Russo. They undoubtedly had their reasons. But, just looking at this process from my headhunting perspective, Mr. Walsh seems to have been the obvious candidate. If they were looking for the strongest horse, they may have fumbled him away.
PERF was recognized as Institutional Investor’s “Large Public Plan of the Year” this spring. A press release on Indiana’s website boasted about it, noting that it validated the fund’s four-year effort to design a portfolio focused on the long-term and built to withstand “dramatic market events.” And PERF had bounced back from its 2008 losses with a zesty 22.61 percent return in FY 2009. But, of course, Mr. Wischmeier, who deserves much of the credit, is now house-hunting in North Carolina, displaced by the re-shuffling and politicking.
Mr. Russo, before his appointment as director of TRF in 2008, worked in operations and engineering jobs. Apart from his old-school tie to Purdue University, and being stationed in Indiana as a manager for Thomson Technology, it’s not immediately obvious why he was tapped to run the state’s public pension.
Mr. Cooper, a Purdue MBA, is clearly an able guy and we congratulate him on his appointment. As we noted in a previous letter, Institutional Investor listed him as a “Rising Star” earlier this year, and now he’s rising as predicted. But, at age 37, he doesn’t yet appear to have the heft that Mr. Walsh would have brought to the position, at least as far as anyone could deduce just by comparing their resumes.
Mr. Cooper made $125,000 before the re-shuffle. That may be fine with the legislature, but, unless he gets a big bump, we wonder how long they can keep him.
The CIO salary conundrum:
We like to cite endowment, foundation, and pension fund salaries to give our readers a frame of reference. That’s in case you’re wondering how you stack up against a hedge-fund honcho, an endowment manager, a humble public pension CIO, or even the anointed partners of Goldman Sachs.
Sadly, by Wall Street standards, public pension CIOs are very modestly compensated. The numbers improve somewhat in the corporate pension space, and gyrate wildly in the endowment and foundation world.
Consider Tim Walsh, the new CIO of the $68 billion dollar New Jersey Pension system. For running this mountain of money he’s paid $185,000, just under a statutory cap of $200,000, not much more than a tip among the hedgies up in Greenwich. David Swensen, the Yale endowment wizard is now up to $5.3 million for running $18 billion, including benefits; and his loyal deputy Dean Takahashi gets $3.5 million. It’s generally assumed that either of these gentlemen could command a large multiple of that if they were willing to fold their Yale Blue flag and take a Wall Street job. One wonders how many offers they turn down every year.
On the hedge fund side, things are very different. The base salaries barely cover the rent, but the bonuses can be delicious. Analysts are usually paid a base of $150,000 to $250,000. But depending upon the quality and outcomes of the analyst’s research and the overall performance of the firm, the bonuses can be as much as three times that. And that’s for a grunt analyst. A portfolio manager doesn’t make much more in base pay, but his bonus, based on results, could be anywhere from $500,000 to $5,000,000, or more.
And we all have read what founding partners of the top firms have made. Soros, Paulson, Simons, Cohen, Tepper, et al., have banked hundreds of millions in good years.
Of course, hedge fund employees are often fired on a whim and the funds can crash overnight, but as we have noted in this letter, job security isn’t all that great on the institutional side either. Moreover, as we report below in the pieces on the Indiana and New Mexico pension funds, the politics can get you even if the performance doesn’t.
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Required Reading: Institutional Investor on Jeff Scott’s Alaskan Innovations
I’ve had some good talks with Jeff Scott, who became chief investment officer of the Alaska Permanent Fund in late 2008. He’s an accessible, plain-speaking guy and we’ve enjoyed chatting about business and about Michigan, where we both spent some of our younger days.
Now, Institutional Investor has done an excellent, in-depth piece on Jeff and how he’s shaking things up in Juneau. Writer Frances Denmark did a terrific piece of research and writing, and I strongly suggest that anyone running institutional money take a look at it:
See: “Jeffrey Scott Forges Trail for Alaska’s Sovereign Wealth Fund”
When Americans hear about sovereign wealth funds, we think Kuwait, Norway, Singapore and so forth. But we have a substantial SWF right here in the USA: the $33 billion APF, established to receive and invest the royalties from North Slope oil production for the benefit of all Alaskans.
Jeff’s views are clear. As he says: “Trying to manage to a return is a naive approach to investing….”You need to step back and think about what are the liabilities, how are you going to cover those liabilities, and how can you hedge and manage them.”
Jeff was previously in corporate finance at Microsoft in Redmond, Washington. As everyone knows, MS has an enormous cash hoard and, as assistant treasurer, he developed and managed a $56 billion absolute-return global asset portfolio that included investments ranging from cash to commodities. He essentially ran a huge internal hedge fund, and he’s taken a lot of that perspective with him to Alaska.
One striking innovation Jeff and I have discussed is detailed in the article. It’s his use of what he calls “external CIOs.” By handing them seed money of $500 million each, he’s brought in PIMCO, Bridgewater Associates, GMO, AQR, and Goldman Sachs. The deal is that each manager will not only have a free hand to run the money, but also provide consulting, teaching, and methods-sharing with APF. Bridgewater, for instance, lets APF use its proprietary risk-budgeting tools and has consulted with APF on a range on assignments.
Such eminentoes as PIMCO’s Mohamed El-Erian and Bridgewater’s Robert Prince trekked all the way up to Juneau to help lead brainstorming sessions for the APF leadership this spring. And, Cliff Asness of AQR will visit at the end of September. Jeff says: “I’ve recruited a team. There’s not one voice anymore. There’s six of us now.”
Jeff, who took the job for $348,000 (probably a cut from what he made as a consultant to several technology companies) is in the same position as most money-managers working for public authorities, feeling cramped by the relatively modest salaries he can pay his managers. Not to mention the challenge of luring good people up to Alaska. One of his senior portfolio managers actually telecommutes from Anchorage, which is a big city compared to the little, landlocked state capital of Juneau. The external-CIO team is an ingenious way of working around those limitations.
Even with degrees from non-Ivy schools (University of Idaho and Central Michigan University), Jeff has still been able to negotiate his way into top jobs at Dow, Microsoft, and now APF; and those people-skills have been absolutely essential in Alaska.
APF is the crown jewel of the state, jealously guarded by politicians and the general public. Persuading his board and the legislature to countenance some of his “radical” changes was the toughest challenge that he faced. This is probably the biggest takeaway from the article, and any money-manager who has had to educate his non-financial constituents and higher-ups will surely sympathize.
Credit Suisse White Paper: “Long-Short Strategy Said to Improve Risk-Free Returns”
In our last letter, we heard from two third-party marketers arguing for the benefits of hedge funds for pensions. This paper provides more support for that position. Credit Suisse argues that – for the subset of hedge funds that are classic long-short equity strategies – they provide better risk-free returns than the kind of long-only portfolios run by many pensions.
Mr. DiNapoli Makes a U-turn in Westchester:
New York State Controller Thomas DiNapoli, sole trustee of the state pension funds, executed a neat course-reversal recently.
While campaigning in leafy, prosperous Westchester County three weeks ago, he excoriated a political opponent whosuggested that the pension’s projected rate of return — currently 8 percent — was unrealistic and should be lowered. Mr. DiNapoli riposted that any such change would require a tax increase on the good citizens of Westchester and the Empire State at large, and that he was horrified at the prospect.
A few days later, he quietly issued a statement allowing as how a reduction from 8 percent to 7.5 percent would probably be prudent.
Republican candidate and former hedge-fund executive Harry Wilson, running against Mr. DiNapoli for the controller’s job, had said that 8 percent ROI is unrealistic, and that the number should be 5 percent or 6 percent, the same figure used by corporate America.
We did our own quick, back-of-the-envelope calculation, which suggests that dropping the ROI in New York State by even just a half-percent would cost the taxpayers an additional $1 billion per annum, more or less. That’s less than the $10 billion increase implied by a drop to 5 percent, but it’s still serious money.
In fact, when he officially announced the move on September 2, he put the increase in employer contributions at $900 million. At the same press conference where he reduced the expected return to 7.5 percent, he also said that the pension had earned a negative 4.4 percent in the most recent quarter. And therein lies the problem: the prospect of low or historically volatile returns that may fall well short of the median 8 percent still used by most public pensions.
Mr. DiNapoli would probably have preferred to perform this climbdown after the election, but an official actuary’s report urging the move may have forced his hand.
We noted above that Virginia has just lowered their own projected ROI from 7.5 percent to 7.0 percent. These fractions of a point don’t look too exciting until you translate them into billions of dollars per year. And holding them high enough to be politically comfortable in the short run can eviscerate a fund in the long run.
For an extreme case of what happens when the return figure is too optimistic, consider the city of Pittsburgh. In order to keep the state from seizing control of its pension funds, the city is now selling its parking meters, hoping to get the funding ratio back up above 50 percent. Back in the 90s they decided to ease their pension contributions by pegging the expected return at 10 percent. Now the bill has come due.
Inflation, Deflation, or No-flation? The Heavyweights Square Off:
All the sages seem to be even more uncertain than usual about the immediate financial future. Tyler Durden, on his ZeroEdge Blog last month, looked at one clash of the titans. We quote Mr. Durden verbatim:
Some days ago, Business Week pointed out that “Warren Buffett shortened the duration of bonds held by his Berkshire Hathaway Inc. after warning that deficit spending could force inflation higher.” As the article further pointed out, twenty-one percent of holdings including Treasuries, municipal debt, foreign-government securities and corporate bonds were due in one year or less as of June 30, Omaha, Nebraska-based Berkshire said in a filing Aug. 6. That compares with 18 percent on March 31, and 16 percent at the end of last year’s second quarter. The conclusion: “It may be a sign that Buffett expects interest rates to start rising, maybe sooner than the conventional wisdom.”
Yet very curiously, as we pointed out, another capital markets titan, Bill Gross with his trillion+ in fixed income securities courtesy of Pimco’s numerous asset managers, has done precisely the opposite. As the chart below demonstrates, Gross’ flagship Total Return Fund has been doing the inverse of Buffett, and has been actively increasing the duration of his bonds over the past two years, with the current blended maturity profile being the most long-end weighted in years: in fact the percentage of bonds maturing in 3 years or less is now the lowest it has been since October 2008.
Using the above logic, it would signify that, unlike Buffett, Gross is now more primed for deflation than ever. In the great inflation-deflation debate, this will be the primetime heavyweight cagematch to watch. Between Buffett’s empire and Pimco’s FI monopoly, one of the two will have to lose. Our question of the weekend is who will it be?