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New law restricts investment discretion of Texas Employees’ staff

Charles Thomas 'Tom' Tull
Employees Retirement System of Texas Chief Investment Officer Charles Thomas ‘Tom’ Tull

Investment officers of the $26.5 billion Employees Retirement System of Texas, Austin, will be restricted in the amount they can commit to alternative investments without board approval effective Sept. 1.

The investment governance change, included in an otherwise routine statute modification, limits the amount ERS staff can commit to or invest in individual private equity, real estate, infrastructure, credit or hedge fund vehicles to 0.6% of plan assets at the end of each fiscal year (Aug. 31).

That's equivalent to about $155 million per deal.

Staff investment delegation to individual alternative commitments under ERS' current investment ​ policy are limited to the lesser of $200 million, or 0.75% of total plan assets or about $194 million per deal for private equity and real estate. In infrastructure, staff is limited to the lesser of $150 million or 0.5% of assets.

Investments in hedge funds under the current policy are limited to the lesser of $250 million or 1% of plan assets per deal. The limit for credit investments was not provided in an ERS Feb. 8 investment governance review.

While the difference between the new discretionary investment limit and the current limit is small, sources in the Texas public pension plan community blame the fallout from pension difficulties experienced by the $2.1 billion Dallas Police & Fire Pension System for the Legislature's interference in ERS' investment governance.

Rehabbing governance

Given the current climate of legislative distrust, other Texas municipal funds likely will start rehabbing their governance, lowering their assumed return rates and cleaning up their investment processes to avoid legislative interference in their governance processes, industry sources said.

Massive participant withdrawals from the Dallas system's deferred retirement option plan and poor investment decisions brought the system's funded status to 36% and required legislative changes to prevent the plan's collapse.

Gov. Greg Abbott signed reform legislation for the uniformed employees' system on May 31 that addresses severe underfunding issues and increases board oversight of investment staff actions, but a bad taste remained in the mouths of state legislators, insiders stressed.

"There's always an overreaction to a black swan event like the Dallas situation," said one source who asked not to be identified, adding "with the international spotlight on Dallas, legislators felt like they had to act to rein in the investment oversight when it came to the ERS legislation, even if ERS' situation was nothing like that of Dallas."

Like other public pension plans of larger Texas municipalities and entities, including the $139.7 billion Teacher Retirement System of the State of Texas and the $736 million City of Austin Police Retirement System, the Employees Retirement System is governed by state statute.

The state's Sunset Advisory Commission is required to conduct a complete review of each state agency every 12 years; ERS was reviewed in 2016 and the Legislature received the commission's recommendations in January.

Most of the commission's recommendations focus on changes to ERS' administrative processes and benefits issues, with the addition of the limits on investment discretion as well as a requirement that ERS develop a consistent way to publicly report the profit share, including the performance fee, incentive fee and carried interest, earned by each investment manager of an alternative investment.

Mr. Abbott signed the bill containing the ERS statute changes on June 9, leaving the system's staff and board of trustees less than three months to effect the new investment and administrative requirements.

"While the Employees Retirement System of Texas believes the current delegation process is prudent and represents best practice standards, ERS fully respects the Texas Sunset review process and our staff is already working to implement the bill's recommendations and requirements in a manner that appropriately supports the benefit programs all state employees rely on for financial and health security," said Charles Thomas "Tom" Tull, ERS' chief investment officer, in an email.

"The requirement limiting staff delegation of alternative investments to no more than 0.6% of the trust's value is not materially different from the existing board-approved delegation policy of 0.75% and will be easily implemented by the legislation's effective date on Sept. 1," Mr. Tull added.

Awaiting actionAustin Police Retirement System is among Texas public plans that aren't waiting for state legislators to train their sights on board governance, investment discretion or assumed rates of return with an eye toward changing them.

Trustees of the policemen's defined benefit plan have on their "own initiative diligently looked at self-improvement in recent years, including before my arrival (16 months ago) and long before the situations in Dallas and Houston became well-known," said Patti Featherston, executive director, in an email.

The board actions included governance, ethics policy, investment strategy and the benefits structure, Ms. Featherston said, stressing investment decision-making discretion remains with trustees.

In 2015 and 2016, the Austin police fund board ensured that certain plan features, such as the DROP, are better aligned to be actuarially neutral, which already has had a correlated favorable impact to the amortization period, said Ms. Featherston.

"This was a significant and courageous act by the board, but trustees knew it was important for the sake of the long-term funding of the system," she said, adding the board "decided several years ago to take a stair-step approach to reducing the assumed rate, which will reach 7.5% in fiscal year 2019. Naturally, that can be re-evaluated should any further reduction seem warranted."

APRS' current assumed rate of return is 8% according to the plan's investment policy statement.n