In this issue:

Cornell’s new CIO — A.J. Edwards steps up to the plate

Interview with Curtis M. Loftis — South Carolina treasurer pushes back on fees

New Search — Director of Investments for a family office

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Comings and goings:

Cornell Decides to Buy American: A.J. Edwards steps up to the plate:

A.J. Edwards, interim chief investment officer at the $5.3 billion Cornell University endowment for the past year, has now been officially bumped up to permanent CIO. But he’s a native of Connecticut, so his selection is a big departure for the upstate-New York school, which has looked to London for all its CIO needs in recent years.

James Walsh, recruited from the giant British Telecom pension, had the job from 2006 to 2010. He was briefly succeeded by another Englishman, Michael Abbot, who had been CEO of fund of hedge funds giant Robeco-Sage; but Mr. Abbot lasted barely six months, leaving last April under rather mysterious circumstances.  (We note that Robeco-Sage evened things out by replacing Mr. Abbot with a Yank: ex- U.S. Army Captain Jill Schurtz, a graduate of West Point and Columbia Law. Robeco-Sage hired Ms. Schurtz as COO in 2008 and moved her up to CEO on Mr. Abbot’s departure. She then presided over the sale of the London firm to Arden Asset Management.)

Mr. Walsh’s base salary in calendar 2010 was $421,828 and Mr. Edwards will presumably get at least as much. Following a good year — FY2007 when the endowment returned 25.9% — Mr. Walsh doubled his pay, earning a performance bonus of $420 thousand (paid in calendar 2008). But a return of 2.7% in FY2008 earned him a bonus of only $77 thousand. We’re not privy to the incentive formula, but Mr. Walsh apparently beat his passive benchmark by about the same margin in both years, so other factors must be in the mix. In any case, Mr. Edwards probably has a similar bonus opportunity, if and when the markets cooperate for him.

Cornell took a big hit in FY2009, booking a loss of 26%. This wasn’t much different from its peer Ivys – Dr. Swensen’s Yale endowment, for instance, lost 24.6% in the same period – but Mr. Walsh took some harsh criticism. The student reporters at the campus paper served up a story full of progressive politics and bad reporting to the effect that while the endowment plunged, the CIO had profited. An editorial the next day opined that it was “unethical” to pay such a bonus as faculty were being laid off. In fact, Mr. Walsh’s big bonus had been paid back in calendar 2008 for performance in FY2007. A corrected account eventually surfaced, if anyone read it.

Faculty and staff were certainly dismayed as the school slashed budgets and froze spending, and Mr. Walsh was probably not the most popular figure on campus that fall. When FY2010 results were announced a year later, it was clear that Cornell had bounced back handsomely, with a 12.6% gain which surpassed both Yale (8.9%) and Harvard (11%). But by then Mr. Walsh had already resigned — just five months after the Cornell Sun’s misleading headlines. He doesn’t seem to have any hard feeling about his time in Ithaca, however, since he chose to name his new London hedge fund, Cayuga Capital Partners, after the scenic lake which adjoins the Cornell campus.

In the four-month gap between Brits in early 2010, leadership of the investment office devolved upon its three senior investment officers: Mr. Edwards, David McNiff, and John Regan. According to people close to the school, Mr. Edwards was clearly first among equals, forming a good relationship with the investment committee and its long-time chairman: Paul Gould, managing director and executive VP of the New York investment banking firm Allen & Company.

When Michael Abbot abruptly resigned in April of last year, the school issued an opaque press release saying that: “…his style of conducting business is inconsistent with Cornell’s policies and expectations,” and that “the parties concluded that it would be in everyone’s interest to end the relationship.”

According to my sources the administration felt that Mr. Abbot had too many personal side projects which were absorbing too much of his time and attention at the expense of his official duties. The two parties simply disagreed about the scale of his extra-curricular activities, and they parted ways.

It may be that Mr. Abbot succeeded as a derivatives trader, then a sell-side executive at Goldman-Sachs, then a principal in two hedge funds, in large part because of an entrepreneurial style which didn’t comport with the buttoned-down institutionalism of Cornell. In any case, he’s still in the U.S. and apparently still flourishing. On the West Coast he’s a partner and managing director of Terroir Capital in Santa Barbara, which boasts an impressive portfolio of vineyards and boutique luxury hostelries in several countries. On the East Coast he’s listed as a general partner at hedge fund advisor Helios Advisors LLC.

As Mr. Abbot departed, the Cornell higher-ups immediately dubbed Mr. Edwards interim CIO, and they have obviously found no one they liked better during a year-long search.

Mr. Edwards was hired in March, 2008 as part of Mr. Walsh’s push to expand and upgrade the investment office. He earned a BA and MBA at the University of Connecticut, then an MS in mathematics from Fairfield University, also in Connecticut. After eight years as an equity analyst with Wright Investors Service, he was hired to manage the $2.5 billion pension of Northeast Utilities in Hartford, giving him a broad base of experience with all asset classes.

Mr. Edwards declined to be interviewed for this piece which, given all the drama of the past few years, is entirely understandable. But it appears to us that Cornell has got it right this time, and we wish him well.

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This way to the egress: Stan Mavromates joins the out-migration from MassPRIM:

MassPRIM’s long-time chief investment officer, Stanley P. Mavromates, is following his former boss and other senior staff into the private sector. He’s been plucked from the $50 billion Massachusetts state pension fund by Mercer Investments, who will make him their new Boston-based CIO for the Americas on June 25.

He earned $270 thousand last year, including a $235 thousand base and a $35 thousand bonus based on his fund’s most recent 3-year performance.

Just two years ago PRIM lost Mr. Mavromates’ former boss, executive director Michael Travaglini, who is now a managing director at Chicago-based Grosvenor Capital, marketing funds of hedge funds to public pensions.

Then, as now, the legislature was agonizing about performance bonuses for the investment staff. In 2009, despite losing money, the PRIM team beat their 3-year benchmarks, but their bonuses were politically radioactive. One creative solon in Springfield even proposed that no state employee should make more than the governor, who pulls down a princely $177 thousand.

The criticism clearly grated on Mr. Travaglini. As he went out the door he told the press: “I have a wife and three children, and I’m going to provide for them…People can vote with their feet, and that’s what I’m doing.”

Mr. Mavromates had no such pungent exit lines, but his departure speaks for itself. I’m confident that his take-home will double with Mercer.

Mercer Investments, an arm of the giant global consulting company owned by Marsh & McLennan, has been re-vamping its institutional unit under group executive Phil de Cristo and, like everyone else, is trying to move into the outsourcing business. Mr. Mavromates, who will report to global CIO Andrew Kirton, replaces Denis Larose, who is now CIO of the institutional investment group of Guardian Capital in Toronto.

Mr. Mavromates’ rather modest bonus was, inevitably, deemed “controversial.” Massachusetts treasurer Steven Grossman, who is ex officio chair of the PRIM board, said last November that he was “awaiting judgment” about whether to keep PRIM’s bonus system until a compensation committee finishes its review. He did cautiously concede that “recruiting and retention of top flight managers is a major issue.”

Mr. Mavromates, who certainly qualifies as a top-flight manager, has obviously decided not to stick around to see if the politicians decide to cut his pay. In his twelve years as CIO, the fund has racked up some of the best returns among its peers, maintaining PRIM’s perch in the top ten percent of U.S. public pensions, but the investment staff has had no increase in their base salaries since 2006.

Mike Travaglini’s departure in 2010 was followed by three more last year. First, chief financial officer Karen Gershman, who was up for the executive director job herself, turned it down for a more lucrative berth as COO at Health Advances, a Boston-based consultant to medical-device startups. Then, PRIM’s two senior private equity staffers, Wayne Smith and Michael Langdon, were also picked off by headhunters last summer.

Mr. Langdon left to join Hermes GPE in September and help establish its Boston office alongside Delaney Brown, their head of Americas. Mr. Smith, head of PRIM’s $6.8 billion PE program preceded him last August, joining fund of funds manager Pathway Capital Management.

In January the PRIM board finally authorized hiring a headhunter to fill those still-open PE positions.

PRIM under current executive director Michael Trotsky and Mr. Mavromates has been working hard to cut their dependence on fund of funds and reduce fees by shifting to direct hedge fund investments. The plan includes a new senior investment officer for hedge funds to ride herd on those new direct investments. But so far they haven’t filled that job, either.

To summarize: no CIO, no senior private equity staff, and no senior hedge fund staff. Oh, and no interim CIO, either, since Mr. Trotsky has decided that the investment staff will report directly to him until a new CIO comes aboard. Mr. Trotsky has the horsepower for that role — he’s a Wharton MBA with ample experience including five years as a senior VP at hedge fund manager PAR Capital — but he’s going to be a busy man.

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Back from Bismarck: John Geissinger’s Second Act:

John Geissinger, chief investment officer and executive director of the North Dakota State Investment Board and the ND Retirement and Investment Office, announced his “retirement” last month. That word usually denotes a cessation of labor, but in this case Mr. Geissinger, who is still in his early 50s, will immediately be taking another full-time position in Connecticut. Whatever he calls it, he was definitely gone on May 31^st.

The SIB manages several state funds totaling about $5.6 billion, including the state’s PERS pension.

Mr. Geissinger’s duties have been split between two interim successors. Fortunately, there was a Deputy CIO on hand: Darren Schulz, freshly-hired in January, who has been named interim CIO. The SIB has also appointed deputy executive director Fay Kopp as interim ED.

In May, Mr. Geissinger was circumspect about naming his new employer, telling reporter Kevin Olsen at Pensions & Investments only that “My decision is based upon my desire to move closer to family in Connecticut. I will be joining a firm in the private sector, but those details will not be released until I start the position in June.”

Now, June has come and Hewitt EnnisKnupp mentioned deep in a press release last week that Mr. Geissinger will be a partner in its Investment Solutions Group. The note also proclaims that HEK has recently added thirty new positions in the investments group. And they are needed to service 100 new clients since the beginning of the year. HEK now claims to have a total of 460 clients for its investment advisory practice and $2 trillion in assets under advisement.

Mr. Geissinger has rolled up a solid resume with one major glitch. He earned a BA in math and economics from Wake Forest University and an MBA in statistics from NYU. There followed three years as a bond analyst at Aetna Life and Casualty, seven years as a portfolio manager and senior VP at Putnam Investments, then five years running an $8.5 billion bond portfolio at Chancellor/LGT Asset Management. So far, so good. Then in 1998 he became chief investment officer and senior managing director at Bear Stearns Asset Management — even serving as chair of the Risk Committee — where his career came unstuck.

Readers may recall that BSAM contained a couple of hedge funds stuffed full of toxic sub-prime mortgages, managed by Ralph Cioffi and Matthew Tannin. In 2007 both funds collapsed, vaporizing $1.4 billion of customers’ money.

One of those fund managers, Mr. Tannin, had unwisely committed some of his thoughts to e-mail at the time, writing in November, 2006:

“As I sat in John’s office I had a wave of fear set over me that the fund couldn’t be run the way that I was ‘hoping’…And that it was going to subject investors to ‘blow up risk’.”

“John” was Mr. Tannin’s then-boss, John Geissinger.

The risks of baring your soul in an e-mail were perhaps less well understood back then. Mr. Tannin may not have realized, for instance, that all G-mail messages are saved on a server somewhere, and that even Google must bow to a federal subpoena.

In 2009 the two ex-masters of the universe were defendants in a Brooklyn courtroom; and among the prosecution witnesses was their old boss, Mr. Geissinger. By then Mr. Geissinger’s job had vaporized, too, as Bear Stearns collapsed into the arms of JP Morgan Chase with a little matchmaking help from the federal government. Shortly afterward he found work in Bismarck, North Dakota.

Scott Fitzgerald said there are no second acts in American lives; but we wish Mr. Geissinger the best of luck as he takes up his duties in Connecticut.

Today’s Investment wisdom – he said, she said:

It’s hard to get a read on where to invest these days. One public plan CIO I spoke with last week is raising cash as fast as he can because of the “bargains ahead”. Another is going whole hog into equities because he does not want to miss the coming rally. A Swedish fund manager I spoke with last month likes the US housing sector because it’s so “cheap”. But an investor friend of mine at a major foundation says that the best property deals are clearly in Europe, not the States. Huh?

Throwing more mud into the waters, last week I listened to an aiCIO conference call with UFG Asset Management, a Moscow based hedge fund/private equity shop run by Harvard-educated American Charlie Ryan and a hard-working Russian/German staff. They have been investing in Russia for sixteen years and politely pointed out that Russia has no sovereign debt, the budget is in the black, the personal income tax rate remains a flat thirteen percent, most Russians own their apartments debt-free thanks to privatizations in the 90’s, and as a result, disposable income is over 75% of pay. The economy is booming and there are few barriers for global investors in consumer products, white goods, autos, and other consumables. In natural resources, well that’s a different matter. There one swims with the oligarchs and government ministers and it’s probably best to avoid these sectors; which means stock picking is key here as opposed to buying the index, of which two-thirds is commodity-related.

About China, I hear mixed messages, but the consensus seems to be that as long as investors stick with the “eat, drink, wash, wear” industries, there is still money to be made.

Meanwhile, John Burbank at Passport Capital, a major global macro investor, still likes Saudi equities and gold.

I hope that clears things up.

Are Institutional Investors getting their money’s worth?

In the next few issues I’ll be taking a close look at investments costs, both internal and external, and see how fund measure up. What are you really paying? And are you getting what you pay for?

To kick things off, let’s hear from a man who has been relentlessly pursuing answers to those questions, Mr. Curtis M. Loftis, Treasurer of South Carolina

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Investment Fee Pushback in the Palmetto State:

A conversation with South Carolina Treasurer Curtis Loftis:

I ran into Mr. Curtis M. Loftis, the Treasurer of South Carolina, at an investor conference in New York a few weeks ago and we were able to continue our conversation by phone over the Memorial Day Weekend.

Some readers may not appreciate what he has to say, but he doesn’t stand alone. Other public pension leaders are also on record as wanting to push back on management fees, even if they haven’t expressed themselves quite as forthrightly.

Mr. Loftis is a small-business owner and real estate investor who decided, at age 51, to enter politics. In his first try at public office he was elected state treasurer, taking office in January, 2011.

In South Carolina, the Treasurer is one of five members of the State Budget & Control Board, who are the trustees of the public pension; and he’s also one of five votes on the Retirement System Investment Commission, which functions as the investment committee. Additionally, as Treasurer, he is the statutory custodian of the pension funds.

As late as 2007 the state was only permitted to invest in U.S. stocks and bonds and held exactly zero alternative assets. Then a constitutional amendment authorized a more modern, diversified portfolio and a CIO was hired to guide the transition. In just four years the state has jumped into alternative assets with both feet. Today, the system allocates slightly over 50 percent to alternatives [FY2011 CAFR, p. 78]. By contrast, giant CalPERS, which many pensions look to as a model, is only about 23 percent in alternatives, including real estate.

But that big push into alternatives came with a big hike in fees. While alternatives went from zero to fifty percent of the portfolio, annual fees to external managers increased tenfold, from $32 million to $340 million.

Mr. Loftis has hit the ground running in his campaign to scrutinize mounting investment management costs in his state’s $26 billion public pension fund. He’s been interviewed in the Wall Street Journal, Bloomberg BusinessWeek, and the New York Times. We’re pleased he found time to explain his concerns to our readers.

Mr. Loftis is a proud graduate of the University of South Carolina, an avid outdoorsman, and is on record as stating that there is no such thing as an unhappy man on a tractor.

Skorina:

Mr. Treasurer, thanks for taking my call in the middle of a holiday weekend. I’m sure the voters will be glad to know that you’re at your post on a Sunday afternoon while they’re home firing up their grills.

Loftis:

Please call me, Curtis, Charles; and I’m glad to speak to you. I should thank you for coaxing my off my tractor on a Sunday afternoon. I’m afraid I get a little obsessive about clearing my land.

Skorina:

Beating back the wisteria must make a nice break from the office, though, Curtis. From what you’ve told me you spend most of your time trying to decipher all of the investment contracts and legal documents you inherited last year.

Loftis:

I’m afraid that’s right. I campaigned on the issue of transparency in the state’s revenues and expenses, and I’ve discovered that things are even murkier than I expected. Regarding the state pensions, I’ve concluded that we, like many public plans, have no clear understanding of how much we’re paying our hedge fund and private equity managers.

Skorina:

Don’t you get bills and statements from the general partners that specify how much you’re being charged? And isn’t it spelled out in your partnership agreements?

Loftis:

Oh, we get lots of statements, but it’s not that simple, especially with alternatives.

Most firms “net” the expenses against earnings in each period. But they usually DO NOT present a bill at the same time, much less one that explains in detail what services we are being billed for. Often there will be several fees in one “net”, and without that information one can never be sure what is being paid. Fees in a “net” might be management fees, incentive fees, organizational fees, back and middle office expenses, partnership expenses, etc.

Most public plans in the US, whether they admit it in public or not, have significant deficiencies in their back and middle office operations which make it hard for them to track these expenses and to challenge them when necessary. I believe these deficiencies are important but overlooked drivers in the underperformance of these plans.

Only in this bizarre world of public pension plans can a $20 or $30 million bill be presented and paid without explanation. I sometimes wonder what would happen if I sent a Wall Streeter a bill for $30 million, with no explanation!

Skorina:

Curtis, wait a minute. Are you telling me the South Carolina pension system does not really know what they are paying their alternative managers? I find that hard to believe.

Loftis:

That’s exactly what I mean Charles. And it is not just us here in South Carolina; it’s a problem that most plans have! SC is like a laboratory to me…I dive deep into the files, reading contracts and PPM’s and side letters and the like. I find all sorts of problems, then I check with my Treasurer and CIO friends around the country…and they all have the same problems to one degree or another, they are just reluctant to admit it in public.

My big complaint is that it’s too hard to get accurate information on what the managers are charging. Let’s start with the big picture and then work our way down to some specific contracts.

Challenge number one is the system bias against full disclosure. Let me ask you: what treasury or investment office wants news of a bad year for pension fund performance to hit the front page? And they don’t really want details of huge fees to be discussed in the newspapers.

Retired pensioners in my state average about $19 thousand a year. It’s hard to explain to someone in that situation how we justify paying hundreds of millions to Wall Street managers.

And, just to be clear, sometimes I do think those fees are justified. It’s not fees per se that bother me; it’s the lack of transparency. We can’t compare costs to performance until we get a grip on the costs.

Most of those fees and expenses are netted against the pension’s partnership share in a fund. They usually don’t even show up as a separate line-item in the official audited income statement. They’re set out in a foot-note, and sometimes they’re after-the-fact estimates, not audited, real-time numbers.

Wall Street is not unhappy about that netting of fees. The headline risk for them fades away.

Skorina:

So what’s getting in the way of transparency?

Loftis:

Several things: onerous confidentiality agreements, sloppy and delayed billing and accounting, lack of sufficient back- and middle-office staff, over-lawyered contracts and complex fees schemes, and the lack of political will in many pension funds across the nation to become transparent and accountable to the people they serve.

Why do you think I’m in my office seven days a week? It’s not because I have no life, it’s because rigidly enforced confidentiality agreements forbid my senior staff, including, if you can believe it, most state lawyers from reading the documents.

Skorina:

You’re kidding!

Loftis:

It’s true. According to many of these agreements, I can’t let others read this stuff without breaching a contract. Now, I wonder who thought that one up. The investment managers can use their lawyers, but according to the agreements, I can’t use mine. These contracts are rigidly enforced by our state investment commission (the RSIC), even more than by Wall Street. My lawyers can’t see these documents. The Governor’s lawyers can’t see them…even the Attorney General himself can’t see these documents!

It is a way that state investment authorities across the country escape meaningful, credentialed oversight. It is unacceptable and I am working to remedy the situation.

Skorina:

So what is it about the contracts themselves that bother you?

Loftis:

Let me count the ways. First, to put it as kindly as I can, I would say that most of these investment contracts are broadly written but narrowly interpreted. Despite what the contract may say about partnering and sharing, every single cost, fee and charge, down to the last cup of coffee is thrown into one incoherent billing statement or “net” by the manager. That might even include costs which don’t contractually belong to us at all. And it’s catch us if you can.

I can tell you plainly that what is told to us orally by some of these money management firms as to cost sharing and all, comes out quite differently in the fine print in the funding agreements and fee agreements. And these fee structures are really complicated.

I’m not a CPA, but I’ve run a business for thirty years. I do know how to read a contract and work out billing statements, and I can tell you this stuff is thick and dense. There are setup fees, organizational fees (amortized over years), back and middle office expenses, transaction fees, subcontractor fees, trading fees, and more fees.

Let me give you just one big, ugly example. This concerns a certain large alternatives manager, with whom we have placed a considerable amount of money, and whom I shall not name. I noticed that fees, on a rough percentage basis, looked too high. I asked the RSIC, and within a week of my asking, the company restated its fees downward by $18.1. That’s real money, Charles, even on Wall Street! When I pressed for the reason I was told it’s a reporting error!

We are also now renegotiating the fee structure with that firm, and this means better net returns for our pensioners.

Are we the only public plan in the country where this type of reporting error occurs? No, but by requiring these types of analysis, in fact analysis done by very few plans, we are able to prudentially manage what is becoming a significant drag on our plan.

Skorina:

So after all this, do you still think there is a role for hedge funds, private equity, and fund of funds?

Loftis:

Oh, yes; absolutely. Many of these managers are exceptional investors. But I want to know what I am paying and then I can decide if their performance merits the fees. Give me outstanding performance and I can hold still for a higher fee. But transparency has to happen first. And when transparency comes, so does accountability.

My complaint is that I can’t tell you with precision what our fees are. And even performance gets tricky. The consultants and money managers have all sorts of ways to measure the performance and, and they have their own biases. Remember: no one wants to say that they recommended a bad manager or that your client is a turkey.

There has to be an element of trust when you do business with people. If we can’t even trust a firm to bill us properly, how can we trust them carry out their other duties and to generate the performance they’re promising?

Skorina:

So Curtis, what’s the big take-away from all this. If you were giving a speech to your peers, what would you say?

Loftis:

First and foremost: U.S. pension funds are the largest inflows of cash to Wall Street. We are the people who should be driving the bus; we shouldn’t be riding in the back.

Second: most plans don’t yet have the ability to really match performance to costs for the reasons I cited above.

As an aside, I think the GASB rules on pension accounting are misguided. They basically state that if the fees numbers are not readily accessible we don’t have to report them on a separate line…or in other words in a manner that is discernible to the average reader. I love that.

Also, there are these preposterous rate-of-return assumptions that the public plans have in place. They all insist they’re going to earn 7 percent or more going forward. Who believes that? We’ll be lucky to get half that in today’s world.

Skorina:

I really appreciate your time, Curtis. Any last comments before we wrap up?

Loftis:

Well, I love my work and I think it makes a difference, Charles. I know that things are not going to change over night. But public pension funds have the money and we can demand change on Wall Street.

If we can’t level the playing field then we can go back to liquid markets in stocks and bonds until the pain and reverse flow make the hedge funds and private equity shops rethink their position. If that is what it takes to do the deal, then they will come around.

I know a lot of people won’t like hearing what I have to say and the system will eventually chew me up and spit me out. But in the meantime, I can at least begin a national conversation that affects most pension plans and millions of hard-working people. It’s time those of us entrusted with those assets stopped worrying about raising money for the next election and started looking our for the retirees and the taxpayers.

Skorina:

Thanks, Curtis. Enjoy the rest of your weekend.

Loftis:

Good talking to you, Charles. Let’s stay in touch.